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  • The two markets - cash and futures

     
     

    To clearly understand the coffee futures market, a distinction must be drawn between physical (cash) coffee and coffee futures.

    In the coffee cash market, participants buy and sell physical, green coffee of different qualities that will be delivered either immediately or promptly. The cash transaction therefore involves the transfer of the ownership of a specific lot of a particular quality of physical coffee. The cash price for the physical coffee is the current local price for the specific product to be transferred. (Note that sales of physical, green coffee for later (forward) delivery, called forward contracts, are not to be confused with futures contracts.)

    In the coffee futures market, participants buy and sell a price for a standard quality of coffee. The futures transaction centres around trading a futures contract based on physical coffee (or its cash equivalent) at a price determined in an open auction - the futures market. The futures price is the price one expects to pay, or receive, for coffee at some future date.

    • Cash price = price now for coffee (by trading the physical product for immediate or prompt delivery)
    • Futures price = expected price for coffee (by trading the different positions of the futures contract)

    The futures contract is a standardized legal commitment to deliver or receive a specific quantity and grade of a commodity or its cash equivalent on a specified date and at a specified delivery point. Its standardization allows the market participants to focus on the price and the choice of contract month.

    Traders in the futures markets are primarily interested in risk management (hedging) or speculation, rather than the physical exchange of actual coffee. Although delivery of physical coffee can take place under the terms of the futures contract, few contracts actually lead to delivery. Instead purchases are usually matched by offsetting sales and vice versa, and no physical delivery takes place.

    In addition to its pricing functions, the coffee futures market also serves to establish standards of quality and grade that can be applied throughout the industry.

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