• Price risk management as part of marketing

    Forward sales of physical coffee at a fixed price are the most straightforward form of price risk management as part of marketing. The size of the expected crop is reasonably well known, prices are satisfactory, and buyers have enough confidence in the seller to commit to them on a forward basis. This is perhaps the ideal situation, but it is seldom encountered nowadays. And when prices are very low, fixed price forward contracts look attractive only to the buyer.

    Selling physicals forward PTBF buyer's call means growers lose all control over the fixation level, and therefore the price, unless they simultaneously also sell a corresponding amount of futures. But this would expose them to margin calls and potential liquidity problems, assuming they could even find the funds to finance the initial deposits. For more on this see 09.03, Options.

    Selling physicals forward PTBF seller's call might appear to be the answer but this is not necessarily so either. Unless the seller fixes immediately, all such deals establish is a contractual obligation to deliver and accept physical coffee.

    The PTBF sale sets the differential the buyer will pay in relation to the underlying futures position(s), but the general price risk and the decision when to fix remain entirely open. In other words, the PTBF sale does not mean the seller has made a price decision - that will only be the case once they fix. Many sellers are unable to bring themselves to fix at unattractive levels, and in falling markets a good number even roll fixations from one futures position to the next, preferring to pay the cost (usually the difference in price between the two positions) to gain more time in the hope that prices will eventually rise.

    This does not happen only when prices are generally low. In a falling market it is sometimes very difficult for sellers to accept that today they must fix at less than they could have done yesterday or the day before. To avoid such fixation traps one should set internal 'stops' so that fixing takes place automatically when a certain price (up or down) is reached. Such orders to fix can be given to whoever is responsible for the actual execution, basis GTC or 'good till cancelled'.

    Note: When fixed price sales are not feasible the simple alternative is to sell PTBF and to fix immediately, thereby fixing both the base price and the differential which, together, make up the final sales price. If there are concerns about 'fixing too early' or 'what if the market goes up', then one also buys a call option accepting that the cost of this of course comes out of the sales price for the physicals.
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