Where price is the only difference between purchase and
sale, then an offset or "wash out" can be arranged by settlement of
that price difference. Probably the most common occurrence
is in futures trading where the clearing house automatically
offsets matching purchase and sale contracts belonging to the same
party. Most futures contracts are liquidated in this manner. See
08.02.02 for more. Alternatively, an exporter may buy coffee for
stock. To offset the price risk he sells a corresponding tonnage on
the futures market. Once he sells the green coffee he will buy back
the futures. The matching futures purchase and sale now offset each
other and are 'washed out' through settlement of the price
difference. See 09.01.01 for more.
In the physical coffee trade occasions arise when buyers
and sellers find it impractical or undesirable to perform delivery
of a contract: they then have the option of a cash settlement of
the contract. This is commonly referred to as a contract "wash out"
and can only be done with the mutual agreement of buyer and
seller. The only action necessary for a "wash out" is for
buyer and seller to agree on a price. For PTBF contracts (Price To
Be Fixed - see 09.02.00), price is a differential, whereas for
fixed price or "outright" contracts price is the value of the goods
at the time of the "wash out". Tax authorities in most
countries will insist that the wash out price reflect the general
market value at time of wash out.
Once a price has been determined, letters acknowledging the wash
out of the original contract will be exchanged between the
contracting parties. Invoices and payments will be calculated using
the difference between the original contract price/differential,
and the final wash out price/differential. Sometimes an
actual wash out contract is created in which the original buyer
sells back the goods to the original seller. This is done more for
inventory record keeping than contractual necessity.
Wash outs are common to all commodity trading. Common reasons for
wash outs are a seller's inability to cover, to supply the goods
under contract for reasons which cannot be considered "force
majeure" (see 04.05.08), or a buyer's change in manufacturing
schedules.
Posted 17 May 2005