How to trade options? Get acquainted and learn How to Trade Orange Juice Options for Breakfast as a popular soft commodity instrument and explore FCOJ options trading strategies.
26 January, Capital.com – Orange juice is not only a tasty beverage that we drink starting our day or hiding from the summer heat. It’s also one of the sweetest and most popular commodities, highly appreciated by experienced traders.
How did orange juice trading begin?
Orange juice started trading as FCOI in 1945 and took one of the first places among US crops. Originally, it was considered a same-day consumption commodity, due to the lack of processing and storage opportunities. However, a revolution in the development of FCOI (frozen concentrated orange juice) has made it one of the most actively traded commodities in the market.
Today, frozen concentrated orange juice futures are traded on the ICE options trading platform. The measurement of one contract’s worth, 15,000 pounds of solids, is due to its transportation and delivery in tanks or drums. Originally, the main producers of FCOJ were Brazil, the United States, Mexico, and Costa Rica.
What do we know about orange juice as a trading instrument?
Regarded as a high-risk trading asset, orange juice options are recommended only for the experienced traders. This popular fruit juice attracts a bunch of active market participants, from market makers to farmers. Orange juice is included in the so-called alternative class of tradable securities, together with other soft commodities, such as cotton, coffee, tea, and cocoa.
As any agricultural commodity, FCOJ is greatly influenced by weather conditions and some diseases. Moreover, as the majority of orange crop is currently located in Florida (USA) and Brazil, extreme weather events, such as hurricanes or extreme frost, can easily destroy the global supply of FCOJ. Therefore, the orange juice soft commodity is highly volatile and prone to price fluctuations.
In addition to weather conditions, orange juice traders should follow regional consumption habits. An increase of consumption in the countries of origin can reduce the export amount. Vice versa, a decrease in consumption in major supply markets can lead to the price drop.
Today, numerous financial instruments, options, and futures can be used to trade orange juice. As the world’s trading volumes continue to increase, orange juice as a commodity becomes more and more popular.
Learn How to Trade Orange Juice Options for Breakfast
Thinking about orange juice options trading you should know that the FCOJ-A futures contract is regarded as the underlying asset. One futures contract is equal to 15,000 pounds of concentrated orange juice solids.
It indicates that when an orange juice option expires in-the-money (when a call option's strike price is below the market price of the asset, or vice versa, when the strike price of a put option is above the market price), the buyer of the orange juice option can enter an orange juice futures contract. It will give him the right to:
- trade futures contract
- exchange it for real orange juice
- postpone the contract until the next term.
Hedging as an orange juice options trading strategy
Let’s assume that it’s winter and FCOI is worth 120 cents per pound. A farmer expects his oranges to be ready for sale in six months. Nervous that the market price may drop down, he wants to ensure the minimum sale price, let’s say 110 cents per pound, for the time his oranges are ready. It means that the farmer seeks price protection or a hedge for his commodity. A put option contract can help him.
An orange juice put option provides the farmer with the opportunity to sell his assets (oranges) at a particular strike price during a certain timeframe. He chooses the option contract for 120 cents per pound and the corresponding expiry date in June when his oranges will be ready. In this case, he pays an upfront premium that costs 5 cents per pound (5 cents x 15,000 pounds = $750).
Having bought this put option, the farmer will get the right (not an obligation) to take a short position in one futures contract for orange juice at a particular price of 120 cents for the expiry date. It means that he will be able to sell his oranges for 120 cents (120 cents per pound x 15,000 pounds = $18,000).
What can the farmer get?
The market price drops down to 100 cents per pound.
It means that the put option is in-the-money (the strike price is higher than the market price) and the option is worth money. Taking a short futures position the farmer will get 20 cents per pound (120 – 100 = 20 cents per pound). Having paid 5 cents per pound as an upfront premium for buying the option, he’ll get 15 cents of net profit.
Then the farmer can sell his juice at the market for 100 cents and take the total of 100 + 15 = 115 cents per pound. It means that for a contract of 15,000 pounds the farmer will get 15,000 x 115 = $17,250
The market price stays almost the same, let’s say 118 cents per pound.
In this case, the option will be exercised. Getting a short futures contract for 120 cents per pound, the farmer will receive 2 cents of profit and then sell his oranges at the market price of 118 cents. Remembering that he paid 5 cents as the option premium, his net sale price will become 115 cents per pound (118 +2 -5 = 115).
Again, for a contract of 15,000 pounds of the FCOJ, the farmer will get $17,250.
The market price increases up to 140 cents per pound.
In this case, the option will be worthless as the current market price is higher than the strike price of the option. Though the option won’t be exercised, the farmer can still sell his oranges at the market price of 140 cents per pound. Deducting 5 cents he paid as the option premium, his net sale price will comprise 135 cents per pound and it means that he will get $20,250 for a 15,000 pounds contract.
As we can see, all the possible outcomes brought profit to the farmer, decreased the risks and guaranteed the minimum price level (115 cents). From the example, we can see that good old OJ can be a juicy investment, especially for experienced traders, but you should always be careful to learn the risks before trading.
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