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Softs/Agricultural/Dairy
Commodities – CTRM Considerations
This page has
some high level notes about Softs/Ags. This is intended to share relevant
information in the context of CTRM system design.
Outline
1) List of
Softs/Ags
2) Trading
Attributes
3) More on
Cocoa
4)
Considerations for CTRM system design
1) List of Softs/Ags
‘Ags’ is short for ‘agricultural’. Sources seem to slightly differ on what is considered
a ‘soft’ versus an ‘agricultural’ commodity, so we are using this as a generic
term. And even
including things like dairy products in this list. i.e., trying to capture the
non-energy, non-metals commodities.
Example
Commodities
1.1) Coffee
1.2) Cocoa
1.3) Sugar
1.4) Wheat
1.5) Nonfat
dry milk
1.6) Soy
1.7) Cotton
1.8) Frozen
Orange Juice
See this for a
fuller list and for specific grade/contracts:
https://www.theice.com/products/Futures-Options/Agriculture
2) Trading Attributes
2.1) Units
May trade in pounds or MT (metric tons), which is also called ‘tonnes’.
2.2) Trade
Types
Precious
Metals will trade as
Futures
Options on
Futures
Swaps
(financial derivative)
Financial
Options
Physical Buys
and Sells
2.3)
Currencies
These are
commonly traded in USD and GBP
3) More on Cocoa
3.1) By
‘Cocoa’ we are referring to
3.1.1) Cocoa
Beans
3.1.2) Cocoa
Butter
3.1.3) Cocoa
Powder
3.1.4) Cocoa
Liquor
3.2) Cocoa
Beans are the original source thing and the others, Butter, Power, and Liqueur
are derived from the Beans. Similar to
the way unleaded gas is derived from Crude Oil.
3.2) Cocoa
Bean futures are activity traded, and these can be used to hedge market
risk. However, there are no futures
contracts for Butter/Power/ Liquor.
Suppose you
need a physical amount of 100 MT per month of Cocoa Butter to make some
product, e.g., candy bars, and you need it for the next 12 months, so 1200 MT
in total. Eventually you’ll need to buy
the physical product so as to be able to use it in your factories. In the meantime, to hedge your market risk,
you can do so by buying futures in the futures market. When you later on buy the physical, you can
sell your futures (‘unwind’ them) and you will have effectively locked in a
certain price.
The problem is, there are no futures contracts for Cocoa Butter, only
Cocoa Beans. And the price movement is
not one to one, so hedging 100 MT per month of Cocoa Butter with 100 MT per month
of Cocoa Bean futures won’t work.
3.3) Butter to
Bean Ratio
There is a
term called the ‘Cocoa Butter to Cocoa Bean Ratio’ (or just ‘Butter to Bean’
ratio) that describes the relevant price movement. It ranges over time from about 1 to 1 to
about 3 to 1. If, for example, it was
currently at a value of 2, that means if you have 100 MT of price risk for
Cocoa Butter, then you would need to hedge with 200 MT worth of futures
contracts of Cocoa Beans to be fully hedged.
Note that the contract size for Cocoa Butter futures is 10 MT, so that
means you would need to buy 20 futures contracts.
4) Considerations for CTRM system design
4.1)
Multi-Currency
Need to be
able to support pricing base metals in multiple currencies, e.g., EUR, USD, GPB. Ideally with minimal extra setup and nothing special to maintain on
an ongoing basis.
4.2) Price
‘Curve’ – Fewer Months
One of the big
differences for base metals versus other commodities is the term structure of
its forward curve. Whereas energy
commodities tend to be monthly, i.e., 12 price points per year, for base
metals, for softs, there are only 5 actively trades months per year, March,
May, July, September and December.
For physical
needs, a firm may need physical product (i.e., to run factories) all 12 months
of the year. If a firm needs physical in
January and wants to hedge their risk, they would likely buy the March futures
contract as it is the next one available.
CTRM systems
need to be able to transform timewise between physical market risk exposure,
which may be in one month, and futures month exposure, which may be in a
different month.
Some firms may
want to average the futures months, so if you have need for physical product in
June, you might hedge partly with the May contract (until it expires) and
partly with the July contract. A CTRM
system needs to be able to accommodate this.
This attribute
of softs is one of the most notable things that CTRM system designers encounter
when designing a system for softs/ags versus energy
or other commodities with futures markets for all 12 months of the year.
4.3) Risk
Reporting
Besides the
time transformation between market risk on physical versus futures contract,
also need to take into account the ‘ratios’ (butter to bean, powder to bean,
liquor to bean) in any risk reporting.
Reports need to be clearly labeled as showing either
4.3.1)
Physical volumes, e.g., 100 MT Cocoa Butter physical
4.3.2) or… Futures equivalent volume.
E.g., with a butter to bean ratio of 2.1, the
above would be 210 MT equivalent of Cocoa Bean futures.
Introduction to
CTRM
Click on this
link for a great introduction to CTRM software: Introduction to CTRM Software