9.5.2-HEDGING AND OTHER OPERATIONS-TRADE HEDGING
Traders use the same basic hedging techniques described earlier in Chapter 09. They sell coffee short and buy futures against the short. They also buy coffee long and sell futures against it. Traders also use PTBF contracts to assure hedging differentials both on physical purchases and sales.
There are different aspects to trade hedging. A good trader will know how to play the seasonality of the coffee they are transacting. Obviously, the buying differentials are usually better when the coffee being bought is in the middle of the crop and availability is plentiful. Selling differentials on the other hand are usually best when the type of coffee being sold is between crops and therefore not in plentiful supply just then.
A good trader will also be aware when a type of coffee is being oversold or undersold. Sometimes producers hold back on their sales. This is usually a sign that over time the differential for that type of coffee will become a more attractive buy. On the other hand, sometimes traders are too quick to sell a certain type of coffee short. Later, short covering can then push the differential for that coffee to a premium over the normally expected physical/future spread. Trade houses are usually prepared to offer physical coffee up to one year in advance provided they are comfortable with the differential.
In order to secure a large forward sale trade houses would usually be prepared to offer a discount from the prevailing price for prompt shipment offered by exporters provided they expect a normal supply of coffee over the period. Trade houses have an advantage over exporters in that they can offer a range of different origin coffees for the industry to use in their blends. This enables them to transfer to an alternative origin if there are supply problems. However, the trade house also has to manage the risk of margin payments, which can be significant during the life of a long-term supply contract. Trading in and out against forward sales together with effective use of hedging can sometimes enable trade houses to be more competitive than origin on long-term contracts.
The specialty business in the United States has made new hedging demands because many transactions represent less than one lot of futures.
To effectively hedge a position in specialty coffee it is therefore necessary to basket trade: the trader has to group the purchases and sales together, into a basket if you will, and adjust those hedges from the position as a whole, for example by lifting a hedge when the equivalent of two-thirds of a box of physicals has been sold. The introduction by the New York Board of Trade in March 2002 of a Mini New York 'C' contract of just 12,500 lb (the Mini 'C'), was in part meant to address such issues and to facilitate access to hedging operations for smaller growers and exporters, and smaller operators on the import and consumption side. See 08.04.05.
The examples of the selling hedge and the buying hedge are discussed in 09.01.04 and 09.01.05. How effectively one puts these hedges on and takes them off again is a lifelong training exercise. It is not just the trader's feel for numbers - they must also have a feel for the coffee they are transacting.
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