Jun 25, 2022
Given that orange juice is one of the most consumed fruit juices in the world, the trading of orange juice draws a diverse group of market players. These market participants include growers, processors, storage houses, market makers, and arbitrageurs. This presents a significant benefit over futures trading. This convenience comes at the expense of an option premium that must be paid in advance and is non-refundable.
Trading orange juice may be done using a variety of financial instruments, including futures and options, among others. A futures contract is a legal commitment to purchase or sell a commodity at a specified price for delivery on a particular date in the future. This convenience comes at the expense of an option premium that must be paid in advance and is non-refundable. The price of the commodity is fixed in advance. Futures contracts are standardized, meaning they have predetermined quantities and delivery dates. These contracts are traded on a futures market.
On the other hand, an option contract grants the holder the right (but not the obligation) to buy or sell the underlying asset at a particular price (referred to as a strike price) on or before the contract's expiration date. However, the holder is not required to exercise this right or obligation (called the expiry). As an alternative kind of tradable assets, soft commodities are now included in market participants' investment portfolios. This trend is expected to continue. The term "soft commodities" refers to agricultural goods often trade on commodity markets using standardized contracts for their purchase and sale. The following are examples of soft commodities:
Before 1950, orange juice could only be considered a "same-day consumption item," also known as a "perishable commodity," due to a lack of storage and processing facilities. The invention of frozen concentrated orange juice in the 1950s brought about a sea change in the orange juice business (FCOJ). Orange juice was transformed into the most popular fruit drink in the world and the commodity it is today by processing, freezing, and adding flavoring ingredients.
This is the trigger price for the option. This indicates that the strike price is more than the current price of the asset, and as a result, the option is valuable and worth purchasing. The farmer is going to take advantage of this possibility.
At 135 cents, the farmer can purchase the short futures position. Because of their future position, he will earn a profit of 25 cents per pound (135 cents per pound less 110 cents per pound = 25 cents per pound). He will collect $19,650 since the contract is for 15,000 pounds multiplied by 131 cents per pound.
Using a put option on orange juice contracts has resulted in two advantages accruing to the farmer in every one of the potential outcomes. In addition, he can profit from any price increases, which means that his downside risk is mitigated by the fact that a minimum price level of 131 cents is guaranteed. This comes at the expense of a charge for the choice equal to four cents per pound.
Currently, one unit of FCOJ can be purchased for 135 cents. The processor is afraid that orange prices may increase, so he wants to cap his buy price at no more than roughly 140 cents per pound. This will allow him to maximize his profits.
In this situation, using orange juice options ensures a maximum capped purchase price in all possible outcomes, with the added advantage of a reduced buy price if the market price decreases. The producer and the customer may successfully protect themselves from the downside risk by paying a portion of the cost in the form of an option premium. Futures contracts are standardized, meaning they have predetermined quantities and delivery dates. This allows them to maintain high upward profit potential or prospective savings.
In a perfect world, one may hedge risk, speculate, or engage in arbitrage using futures or options. On the other hand, long option positions do not need margin money and do not need daily mark-to-market calculations as futures do. This presents a significant benefit over futures trading. This convenience comes at the expense of an option premium that must be paid in advance and is non-refundable. Additionally, this premium is susceptible to time decay. Short options do need margin funds.