What is an orange juice transaction?
Trading orange juice is popular worldwide and trading volumes continue to grow. The trade in orange juice, one of the most popular fruit juices in the world, attracts a wide range of market participants, including farmers, processors, depots, market makers and arbitrators.
Multiple financial instruments such as futures and options are available for trading orange juice. A futures contract is a legal obligation to buy or sell an item at a given price for delivery on a particular date in the future. Futures contracts are traded and standardized on futures exchanges. In other words, the amount and delivery date are set.
Option contracts, on the other hand, give holders the right (but not obligation) to buy or sell the underlying asset at a specific price (called the exercise price) at or before the contract’s expiration date (called maturity).
This article describes how options trading, trading scenarios, orange juice trading markets, participant profiles, risks, rewards, and determinants of orange juice contracts affect the options price of orange juice trading. The Orange Juice option on the ICE Futures Exchange is taken as an example cited throughout the article.
- Trading orange juice is popular worldwide and trading volumes continue to grow.
- The orange juice trade attracts a wide range of market participants, including farmers, processors, depots, market makers and arbitrators.
- Multiple financial instruments such as futures and options are available for trading orange juice.
- In orange juice options trading, the underlying asset is one FCOJ-A futures contract equivalent to £ 15,000 of concentrated orange juice solids.
What is an Orange Juice Option Contract?
Soft commodities are currently finding a place in the investment portfolio of market participants as an alternative class of tradeable securities. Soft commodities are usually agricultural products that are bought and sold through standardized contracts on commodity exchanges. Examples of soft products are as follows.
- Orange juice
Prior to 1950, the lack of storage and processing capacity limited orange juice to so-called same-day or perishable products. In the 1950s, the orange juice industry revolutionized with the development of frozen concentrated orange juice (FCOJ). Orange juice, through processing, freezing and seasoning, is the world’s most popular fruit drink and is now a product.
In orange juice options trading, the underlying asset is one FCOJ-A futures contract. One such futures contract is worth £ 15,000 of concentrated orange juice solids. This means that if the orange juice option contract expires in the money (ITM), the buyer of the orange juice call or put option will have the right to enter into a long (purchase) or short (sale) orange juice futures contract. It means that.
The contract owner takes one of several actions, such as trading (selling / purchasing) a futures contract, exchanging for physical orange juice, or rolling over the contract to a futures contract for the next period. I can do it.
Use of orange juice option for hedging
While market making, arbitrage and speculation continue to be the focus of commodity trading, hedging is the main purpose for which a large number of commodities continue to be able to trade on major global exchanges. Hedging is made possible by derivative products such as futures and options that producers and consumers can use efficiently to achieve risk management.
Put an option hedge
In January, assume that frozen concentrated orange juice is currently trading at 135 cents / pound (spot price). Orange farmers expect their crops (one unit of FCOJ, or £ 15,000) to be available for sale by June (within six months). Farmers are nervous about price cuts for oranges in the near future and want to secure a minimum selling price for oranges (for example, about 130 cents per pound) in case the crop is ready. Farmers are looking for hedges and price protection for their crops. To do this, he can buy one orange juice put option contract.
Put options give farmers the right to sell their underlying assets at a specified sale (or exercise) price within a specific period of time. Orange farmers choose an option contract that has a strike price of 135 cents and expires in June when the crop is ready. He pays a prepaid option premium of £ 4 per pound (4 cents x £ 15,000 = $ 600).
Purchasing Put Options gives Orange Farmer the right, but not an obligation, to take a short position on one Orange Juice Futures contract at a given price of 135 cents at the expiration of the option. This futures contract gives him the right to sell oranges at this given price (135 cents / pound x £ 15,000 = $ 20,250).
For simplicity, all the above examples use 1 unit of frozen concentrated orange juice. The reference to orange or orange juice refers to one unit of frozen concentrated orange juice. The next section describes realistic calculations.
Orange Juice Price: Below Put Strike Price
If the price of orange juice drops to 110 cents per pound, long orange juice put options will make money. This means that the strike price is higher than the market price, so the option is worth the money. The farmer exercises the option.
Farmers get a futures position for 135 cents. He earns 25 cents / pound from futures positions (135 cents / pound – 110 cents / pound = 25 cents / pound). He paid a prepaid option premium of £ 4 / pound and made a net profit of £ 21 per pound. He can sell orange juice at a market price of 110 cents, for a total selling price of 110 + 21 = 131 cents / pound. For a £ 15,000 contract, he receives 15,000 * 131 cents = $ 19,650.
Orange Juice Price: At Put Strike Price
If the price of orange juice remains at about the same level (for example, 133 cents) at the time of expiration, the option will be exercised. He signs a short-term futures contract at 135 cents and can square it at 133 cents, bringing a profit of 2 cents. He sells orange crops at a market price of 133 cents. After deducting the 4 cents he paid as an option premium, his net selling price is 131 cents / pound (133 + 2-4 = 131 cents / pound). For a £ 15,000 contract, he receives $ 19,650.
Orange Juice Price: Above Put Strike Price
If the price of orange juice rises to, for example, 150 cents at the time of expiration, the option expires worthlessly (because the current price is higher than the strike price of put options). Farmers cannot exercise options and do not enter into short-term futures contracts.
But he will be able to sell orange crops at a market price of 150 cents per pound. After deducting the 4 cents paid as an option premium, his net selling price is 146 cents / pound (better than the expected level of 130 cents / pound). For a £ 15,000 contract, he receives $ 21,900.
Benefits of orange juice put options
Using the orange juice contract put option provided farmers with dual benefits in all possible scenarios. His risk is limited to the downside of being guaranteed the lowest price level (131 cents). In addition, he can benefit from rising prices. This costs an optional premium of 4 cents / pound.
Call option hedge
On the other hand, consider an orange juice processor who has to buy one frozen concentrated orange juice unit in 6 months. The current price of one unit of FCOJ is 135 cents. Processors are concerned that the price of oranges could rise, so they want to limit their purchase price to a maximum of around 140 cents / pound.
To get price protection, the processor can purchase one orange juice call option. She chooses an option …