Liquidity is a crucial factor in determining the
success of a futures market. A futures market must have enough participants with
competing price goals (buyers and sellers) to ensure a turnover high enough to
permit the buying and selling of contracts at a moment's notice without direct
price distortion. Large transaction volumes provide flexibility (liquidity) and
enable traders to pick the most appropriate contract month, corresponding to
their physical delivery commitments, to hedge the price risks inherent in those
physical transactions. More bids to buy and offers to sell in the market at any
given time create greater pricing efficiency for the participants seeking a
price for the commodity. Currently only the New York and London markets provide
this flexibility on an international scale.
Speculators and hedgers competing for price
generally means that futures and cash prices move in the same direction over
time and as a futures contract approaches delivery the futures price and the
cash price will often converge. Futures prices do not always reflect cash market
reality though, especially over the very short term when large volumes may be
traded for purely speculative reasons. The volume of futures trading and the
underlying quantity of physical coffee it represents easily exceed total
production of green coffee, or indeed the volume of the physical trade as a
whole.
The large volumes on the futures markets not only
influence futures prices but inevitably have an influence on the price of
physical coffee as well. It is important for those involved in the physical
coffee business to be aware of the activity of speculators and derivative
traders. For that reason, the futures industry regularly examines and publishes
the ratio of speculative and hedging activity in the market.
Speculators are absolutely necessary to the
efficient function of a futures market. Speculative activity directly improves
liquidity and therefore serves the hedgers' long-term interests. During the last
ten years or so, the activity of hedge funds and the development of options on
futures markets have both led to an increase in short-term speculative
activity.
While options on futures provide another speculative
opportunity in the futures market, options also represent an important risk
management tool that has become very useful in recent years. See also 09,
Hedging and other operations.
Not all options result in actual futures contracts.
However, they do represent potential quantities to be traded on the strike dates
should the holders decide to exercise their options rather than simply letting
them expire. In any event, the large turnover in actual futures demonstrates the
impact of the futures markets on the daily trade in physical coffee.
In recent years physical
prices have largely been determined by applying a differential to prices in the
futures market; that is, the combination of the differential (plus or minus) and
the price of the selected futures position gives the price for the physical
coffee.
The tables below demonstrate the huge growth in volume of the
trade in options and futures:
Annual turnover in futures compared with gross world imports
(millions of tons)
Year
|
New York
|
London
|
Total Futures
|
World Imports*
|
1980
|
15.2
|
5.5
|
20.7
|
4.1
|
1985
|
11.1
|
5.1
|
16.2
|
4.5
|
1985-1989
|
17.7
|
5.4
|
23.1
|
4.7
|
1990-1994
|
37.3
|
5,5
|
42.8
|
5.3
|
1995-1999
|
37.6
|
6.6
|
44.2
|
5.6
|
2000
|
33.7
|
7.4
|
41.1
|
6.1
|
2001
|
37.4
|
7.7
|
45.1
|
6.2
|
2002
|
46.2
|
9.5
|
55.7
|
6.3
|
2003
|
54.6
|
11.6
|
66.2
|
6.5
|
2004
|
71.3
|
15.3
|
86.6
|
7.0
|
2005
|
67.8
|
16.3
|
84.1
|
7.2
|
2006
|
75.0
|
17.8
|
92.8
|
7.4
|
2007
|
84.6
|
22.2
|
106.8
|
7.4
|
2008
|
92.6
|
21.9
|
114.5
|
7.7
|
2009
|
72.4
|
25.2
|
97.6
|
7.5
|
2010
|
93.9
|
27.9
|
121.8
|
7.7**
|
*Gross imports from all sources.
**Estimated
Annual turnover in options and
futures
(millions of tons)
Year
|
New York
|
London
|
Total options
|
Options + Futures
|
1990
|
4.8
|
0.2
|
5.0
|
41.0
|
1990-1994
|
12.9
|
0.7
|
13.6
|
56.3
|
1995-1998
|
16.9
|
0.8
|
17.7
|
42.1
|
1999
|
23.3
|
0.9
|
24.2
|
76.9
|
2000
|
15.5
|
0.6
|
16.1
|
57.2
|
2001
|
13.6
|
0.4
|
14.0
|
59.1
|
2002
|
18.1
|
0.7
|
18.8
|
74.5
|
2003
|
22.6
|
0.7
|
23.3
|
89.5
|
2004
|
33.5
|
1.2
|
34.7
|
121.3
|
2005
|
40.3
|
0.8
|
41.1
|
125.2
|
2006
|
47.2
|
2.3
|
49.5
|
142.3
|
2007
|
49.5
|
3.3
|
52.8
|
159.6
|
2008
|
48.0
|
2.8
|
50.8
|
165.3
|
2009
|
24.4
|
1.9
|
26.3
|
123.9
|
2010
|
39.2
|
4.8
|
44.0
|
165.8
|