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On the market.

On the Market

On August 28, Stephen Platt, vice president/senior analyst at Dean Witter Inc. Chicago, stated: "Over the next six months, coffee prices are expected to trade between 95-120 (basis March). There may be periods of weakness based on technical considerations along with the large stocks in the hands of major consumers, but we expect those periods to be short-lived, given the well sold position of producers, expansion of demand, particularly for higher quality coffee, and tightness in the availability of high quality export-grade coffees." The same day, December future settled at 101.75 [/lb. and March futures at 105.00 [/lb.

We asked Beverly Gordon, vice president of marketing and communications at the Coffee, Sugar & Cocoa Exchange, Inc., to examine the alternatives available to a roaster who concurs with this market opinion and previously sold a combination (selling a put with a lower strike price and a call with a higher strike, both having the same expiration date--see August's "On the Market"). For the roaster with continuous inventory turnover, such a sale would provide a means for effectively obtaining coffee at below market prices and selling coffee above market prices.

Readers may recall that, on August 3, a roaster could have sold a December 90 put and a December 120 call to encompass a forecasted trading range of 88.00-120.00 </lb. With December futures at 94.70 [/lb., the sale would have earned a total premium of 3.65 </lb. (2.75 for the put, .90 for the call).

The roaster who agrees with the new market opinion has a number of strategies to chose from. We will look at two: holding the position or "rolling forward" to the next option month and "rolling up" the strike prices. Before moving on, let's take a close look at the market on both August 3 and August 28:

Based on the market opinion, neither the 90 put nor the 120 call should be exercised. Therefore, the roaster might be comfortable in holding the position until expiration on the first Friday of November. If neither is exercised, the roaster keeps the entire 3.65 [/lb., a profit of 2.04 [/lb is earned on the position.

If the roaster feels that the combination has been an effectively strategy and wants to increase his potential premium income, he can extend the hedge by "rolling forward" to the next option month or "rolling up" to accommodate a new trading range. To roll, the roaster would first close out the existing combination by buying a December 90 put and a December 120 call. On August 28, the put traded at .73 [/lb. and the call at .88 [/lb., 1.61 [/lb. total. Because the combination was originally sold for 3.65 [/lb., a profit of 2.04 [/lb is earned on the position. (3.65 premium received--1.61 premium paid = 2.04).

After closing out the position, the roaster would sell a March 95 put and a March 120 call. [1] The March option "rolls" the position forward, the 95 put strike "rolls" the strike price closer to the lower end of the forecasted trading range. The put sells for 2.30 [/lb. and the call 2.38 [/lb., a total premium of 4.68 2/3/lb. Selling the March combination affords the roaster the potential to earn additional premium income by extending the terms of the options until the first Friday of February, when the contracts expire. When premium income is accounted for, the new combination remains profitable even if futures prices drop to 91.32 [/lb. (put strike minus premium income) or rise to 124.68 (call strike plus premium income). If prices stay between 95.00-120.00 [/lb., the roaster stands to retain the entire 4.68 [/lb. premium received. If the 2.04 [/lb. profit earned from the original combination is figured in, the roaster collects a grand total of 6.72 [/lb.

The ability to "roll forward" and "roll up" strategies provides a vivid illustration of option trading flexibility. As market conditions and forecasts change or time passes with little change, option strategies can be readily modified. For the roaster with rapid inventory turnover, the strategy of selling a combination can continue to meet hedging objectives over long periods of time while being adapted to fluctuating prices and market outlooks.

(1) To reduce costs, the roaster might consider closing out the original position and buying a new position by executing a spread a broker for more information.
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Title Annotation:coffee futures prices
Publication:Tea & Coffee Trade Journal
Date:Oct 1, 1990
Previous Article:Freshness: a quality essential.
Next Article:"Coffee and love awake." (physical effect of caffeine)

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