Download Agricultural Derivatives 101

Agricultural Derivatives
101
The Agricultural Products
Division of the JSE
Copyright © 2005 JSE Limited
Agriculture in South Africa
• 3,5 – 4,0% contribution to GDP (but 40% of population
dependant on agriculture)
• 10% of South African exports (by value)
• Major agric export earner = sugar (maize, wine, fruit)
• Farmers:
50 000 commercial
240 000 small scale farmers
3m subsistence farmers
• 13% of South Africa is arable land (only 20% is high potential)
• Major limiting resource is WATER
• RSA =
6% of African population
4% of African land area
25 – 30% of maize produced in Africa
10% of wheat produced in Africa
50 – 60% of maize produced in SADC
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Agriculture in South Africa
• 1930 – early 90’s
Regulated Marketing
Centralized marketing
Centralized price determination
• 1995
Agricultural market deregulated
Control Boards / Marketing Boards scrapped
NO centralized price determination
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Agricultural marketing in
South Africa is a whole
new ball game
in a deregulated
market place
Agricultural marketing in
South Africa is a whole
new ball game
in a deregulated
market place
Agricultural Markets
• Regulated
Advantages:
Disadvantages:
• Free Market
Disadvantages:
Advantages:
No price risk
Information supply
Cost to economy
Distortion to economy
Price Risk
Information
Unfair Competition
Opportunities
Economic Basis
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Challenges of the Free Market
•
•
•
•
Unfair Competition – not level playing field
One sided – inputs / outputs (no link)
Requires decisions
Requires sourcing and interpretation of
information
• Does not respect tradition or history
• Makes use of technological progress
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Background to Derivatives
• Mesopotamia, China, France, USA - agriculture
• Fluctuating Prices depending on supply and demand
of product
• Forward Contracts
• Standardized Forward Contracts to facilitate
trading
• Add guarantee to the market
• Futures Contracts
• Financial Markets
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A futures market is...
• A trading operation that provides market
participants with a price determination
mechanism and a price risk management
facility through which they can manage
their exposure to adverse price movements
on the underlying physical market and
where performance by both counterparties
to the contract is guaranteed
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It is NOT a “get rich quick” scheme
Copyright © 2005 JSE Limited
…. it is to avoid losing money!
Copyright © 2005 JSE Limited
The Agricultural Derivatives Market in South Africa
•
•
•
•
•
•
•
Establishment of the South African Futures Exchange (SAFEX) in 1988
to trade financial derivative instruments
Establishment of the Agricultural Markets Division of SAFEX in 1995
separate membership
start-up capital raised by the issue of seats
Initial futures contracts (chilled beef and potatoes) not successful
White and yellow maize contracts listed in 1996
August 2001 - became Agricultural Products Division of the JSE
Securities Exchange South Africa
Presently trade maize, wheat, sunflower seeds and soyabean futures
and options contracts
Recognised as the price discovery facility for grains in South and
Southern Africa
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futures contracts .....
• standardised agreement through exchange
(product, quality, quantity, time & place)
• indirect locked-in price
• physical delivery not implied
• profit / loss profile exactly opposite to physical
market
• basis risk
• margins payable
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WHY use a futures market ?
..........for two very good reasons !
• price determination
and
• price-risk management
Copyright © 2005 JSE Limited
Maize Price determinants
• South African Demand and Supply
- role of weather
- input suppliers
- crop estimates committee
• Regional Demand and Supply
- actual economic demand ?
• International Demand and Supply
• Exchange Rates
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Price determination ......
• futures exchanges do not set prices,
they are free markets where the
forces that influence prices, notably
supply and demand, are brought
together in a transparent way.
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How are prices determined?
by brokers representing
clients who trade on a
trading floor (pit) or
electronically on
a trading screen the trading screen
reflects the best bids
(highest) and offers
(lowest).
Copyright © 2005 JSE Limited
JAN 96 BEEF FUTURES CONTRACT
9.75
9.25
8.75
NABI
8.25
7.75
JAN FUTURE
7.25
6.75
O
N
D
J
20
/06
07 /20
/07 03
22 /20
/07 03
06 /20
/0 03
21 8/20
/0 03
05 8/20
/09 03
22 /20
/09 03
08 /20
/10 03
23 /20
/10 03
07 /20
/11 03
24 /20
/11 03
09 /20
/12 03
29 /20
/1 03
14 2/20
/01 03
29 /20
/01 04
13 /20
/02 04
01 /20
/03 04
16 /20
/03 04
01 /20
/04 04
21 /20
/04 04
07 /20
/0 04
24 5/20
/05 04
08 /20
/06 04
24 /20
/06 04
09 /20
/07 04
/20
04
R/TON
July 04 White Maize
1700
1600
1500
1400
1300
1200
1100
1000
900
800
DATE
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.
Copyright © 2005 JSE Limited
2005/04/14
2005/03/31
2005/03/17
2005/03/03
1100
2005/02/17
2005/02/03
2005/01/20
2005/01/06
2004/12/23
2004/12/09
2004/11/25
2004/11/11
500
2004/10/28
2004/10/14
2004/09/30
2004/09/16
2004/09/02
2004/08/19
2004/08/05
2004/07/22
2004/07/08
2004/06/24
2004/06/10
R/Ton
July 05 White Maize
1300
1200
Possibility to lock in
prices of +/- R1000/t
1000
900
800
700
600
Realization of large carry
over and good planting
possibilities
400
Date
20
.
Copyright © 2005 JSE Limited
25/10/2005
18/10/2005
11/10/2005
04/10/2005
27/09/2005
20/09/2005
13/09/2005
06/09/2005
30/08/2005
23/08/2005
16/08/2005
09/08/2005
02/08/2005
26/07/2005
19/07/2005
12/07/2005
05/07/2005
28/06/2005
21/06/2005
14/06/2005
07/06/2005
31/05/2005
24/05/2005
17/05/2005
10/05/2005
03/05/2005
26/04/2005
19/04/2005
12/04/2005
05/04/2005
29/03/2005
R/Ton
July 06 White Maize
950
900
850
Where to
next ??
800
750
700
650
600
Date
21
.
SAFEX nearby White Maize (R/t) since
1998
R/Ton
2300.00
2200.00
2100.00
2000.00
1900.00
1800.00
1700.00
1600.00
1500.00
1400.00
1300.00
1200.00
1100.00
1000.00
900.00
800.00
700.00
600.00
500.00
400.00
24/08/2005
31/03/2005
04/11/2004
14/06/2004
19/01/2004
22/08/2003
28/03/2003
31/10/2002
10/06/2002
11/01/2002
16/08/2001
19/03/2001
24/10/2000
06/01/2000
01/06/2000
08/11/1999
15/3/99
21/10/98
29/5/98
01/05/1998
Date
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Price-risk management instruments ..
• state intervention
• hold physical stocks
• forward contracts
• futures contracts
• options
Copyright © 2005 JSE Limited
To hedge or not to hedge,
that is the question!
Whether it is better for farmers
in the production of maize
to suffer the ups and downs of
outrageous maize prices, or to
take precautions against a sea
of uncertainty and by managing
price risk, end the uncertainty.
RMGB (with apologies)
Guarantee in Market
• Structure of the market
• Margin Payments
- initial margin
- variation margin
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Structure of the Exchange
Clearing House
Clearing Member
Broker
Client A
Client B
Client C
Clearing Member
Trade
Broker
Copyright © 2005 JSE Limited
Client X
Client Y
Client Z
Margin Flows
Date
price
Contract
value
Contract
Action
acc.
Seller’s
Buyer’s
acc.
8/3
R550
R55000
init. margin
R10000
R10000
11/3
R545
R54500
var. margin
R10500  R500 
R10000
(R500)
12/3
R547
R54700
var. margin
R10300  R200 
R10200
15/3
R540
R54000
var. margin
R11000  R700 
R10000
(R500)
17/3
R520
R52000
var. margin
R13000  R2000
R10000
(R2000)
18/3
R510
R51000
var. margin
R14000  R1000  R10000
(R1000)
Seller receives margin R10000 plus profit R4000 (R550-R510 x 100) from the futures market
and R510/t from the physical market. Buyer receives margin R10000, but has lost R4000
(which as a hedger will be compensated for by a lower physical purchase cost: R510/t).
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...... by using the futures market individuals,
companies or countries selling or buying a
commodity can protect themselves against
price movements in the underlying physical
market. This is achieved by selling or
buying futures or options contracts
through a broker who is a member of the
futures exchange.
Copyright © 2005 JSE Limited
Requirements for a Successful Agric Futures Market
• Liquidity in underlying spot market (volume of production,
multiple buyers and multiple sellers)
• Commodity must be able to be standardized
• Price must be volatile (must be a need for price risk
management)
• No state intervention in the price making mechanism
• Guaranteed contract performance (clearing & financial
system)
• Deliverability (infrastructure / grading regulations /
warehouse receipts)
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Growth of the Market...
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Total contracts traded – futures and
options
2500000
Futures
Options
2000000
Contracts
1500000
1000000
500000
0
1998
1999
2000
2001
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2002
2003
2004
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Physical delivery in
completion of a futures
contract….
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Delivery starts at the silo ….
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Why allow for physical delivery on
the futures market.
• no underlying cash market to base prices off
– therefore no cash index available to settle the
futures contract
• guaranteed delivery to the buyer of a Safex
silo receipt representing good delivery
• guaranteed payment to the seller
• standardisation of the contract is required
(quantity, quality, place, storage)
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Delivery onto Safex….
• physical delivery is a two day process on
Safex, first the notice day followed by the
delivery day
• delivery can take place anytime during the
delivery month ie May
• commodity is deliverable all months of the
year, five main hedging months with the
remainder as constant delivery months
• short position holder gives notice any time
during the delivery month
• long position holder is randomly allocated
commodity as deliveries are received
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DECEMBER 2004
M
T
W
T
F
S
S
30
30
11
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
21
22
23
24
25
26
27
28
29
30
30
31
31
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Initial margin requirements
• Contracts traded before delivery require
R10000 for white and yellow maize,
• Extended price limits margins increase
• on the first delivery day margins move to
R13000 per contract and price limits
removed,
• from last trading day to expiry, margins are
increased to R23000 per contract,
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Detail required for delivery…
• A short futures position is required in the
particular delivery month before any notice
can be tendered
• Short position holder tenders notice through
his broker
– the following information is required
•
•
•
•
silo receipt number
quantity
location
date storage is paid to
• Delivery notice is faxed/emailed to Safex
before 12h45 on notice day
Copyright © 2005 JSE Limited
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Copy of a delivery notice
SAFEX DELIVERY NOTICE
WHITE MAIZE FUTURES CONTRACT
JSE VAT REGISTRATION NUMBER: 4080119391
TAX INVOICE NUMBER:
WMAZ286
The undersigned short position holder hereby give notice to the Clearing House of intention to deliver as follows:
Delivery Notice Ref
WMAZ286
SHORT POSITION HOLDER
ClientCode
xyz19
MemberCode
TTT
ClearingMemberCode
STDC
NoticeDate
08-Jul-03
DeliveryDate
09-Jul-03
FuturesContract
JUL 2003 WMAZ
NumberOfContracts
46
QuantityTons
4600
Receipt
Number
808163
806232
806200
806219
806245
795444
793299
792271
791772
Quantity
200
1000
1000
1000
1000
100
100
100
100
Silo
Owner
SWK
SWK
SWK
SWK
SWK
SWK
SWK
SWK
SWK
Silo
Location
Schuttesdraai
Werda
Werda
Werda
Werda
Werda
Mirage
Buckingham
Vierfontein
Storage
Paid To
07-Jul-03
01-Jul-03
01-Jul-03
01-Jul-03
01-Jul-03
27-Jun-03
20-Jun-03
12-Jun-03
18-Jun-03
Days
Storage
2
8
8
8
8
12
19
27
21
Storage Due
Per Ton
0.62
2.48
2.48
2.48
2.48
3.72
5.89
8.37
6.51
Loc Diff
PerTon
67
63
63
63
63
63
62
42
57
Discount PerTon
TotalDiscount
67.62
65.48
65.48
65.48
65.48
66.72
67.89
50.37
63.51
13524
65480
65480
65480
65480
6672
6789
5037
6351
TOTAL DISCOUNT
R300,293.00
For Clearing House use only:
CLOSING FUTURE'S PRICE ON DAY PRIOR TO DELIVERY DAY
GROSS INVOICE AMOUNT
NET INVOICE AMOUNT DUE TO SHORT POSITION HOLDER
R852.00
R3,919,200.00
-------------------R3,618,907.00
--------------------------------------AGRICULTURAL PRODUCTS DIVISION
A DIVISION OF THE JSE SECURITIES EXCHANGE
One Exchange Square
Gwen Lane
Sandown
Copyright © 2005 JSE Limited
Delivery Notice WMAZ286 Page 1 of 1
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Copy of a assignment notice
SAFEX ASSIGNMENT NOTICE
WHITE MAIZE FUTURES CONTRACT
JSE VAT REGISTRATION NUMBER: 4080119391
TAX INVOICE NUMBER:
WMAZ286
The undersigned short position holder hereby give notice to the Clearing House of intention to deliver as follows:
Delivery Notice Ref
WMAZ286
SHORT POSITION HOLDER
ClientCode
CYH20
MemberCode
ABL
ClearingMemberCode
VKSC
NoticeDate
08-Jul-03
DeliveryDate
09-Jul-03
FuturesContract
JUL 2003 WMAZ
NumberOfContracts
46
QuantityTons
4600
Receipt
Number
808163
806232
806200
806219
806245
795444
793299
792271
791772
Quantity
200
1000
1000
1000
1000
100
100
100
100
Silo
Owner
SWK
SWK
SWK
SWK
SWK
SWK
SWK
SWK
SWK
Silo
Location
Schuttesdraai
Werda
Werda
Werda
Werda
Werda
Mirage
Buckingham
Vierfontein
Storage
Paid To
07-Jul-03
01-Jul-03
01-Jul-03
01-Jul-03
01-Jul-03
27-Jun-03
20-Jun-03
12-Jun-03
18-Jun-03
Days
Storage
2
8
8
8
8
12
19
27
21
Storage Due
Per Ton
0.62
2.48
2.48
2.48
2.48
3.72
5.89
8.37
6.51
Loc Diff
PerTon
67
63
63
63
63
63
62
42
57
Discount PerTon
TotalDiscount
67.62
65.48
65.48
65.48
65.48
66.72
67.89
50.37
63.51
13524
65480
65480
65480
65480
6672
6789
5037
6351
TOTAL DISCOUNT
R300,293.00
For Clearing House use only:
CLOSING FUTURE'S PRICE ON DAY PRIOR TO DELIVERY DAY
GROSS INVOICE AMOUNT
NET INVOICE AMOUNT DUE TO SHORT POSITION HOLDER
R852.00
R3,919,200.00
-------------------R3,618,907.00
--------------------------------------AGRICULTURAL PRODUCTS DIVISION
A DIVISION OF THE JSE SECURITIES EXCHANGE
One Exchange Square
Gwen Lane
Copyright
© 2005 JSE Limited
Sandown
.
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Delivery Notice WMAZ286 Page 1 of 1
Settlement as follows…
• broker will deliver silo receipt by 12h00 on the
delivery day
• silo receipt has to be signed off
• payment is finalised by 12h00 on delivery day
• buyer’s broker can pick up silo receipt from
14h00 on delivery day
• initial margin to both buyer and seller will be
returned the following day
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Lets step outside for some
refreshments…..
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Welcome back !
Lets look at your
“OPTIONS”
Copyright © 2005 JSE Limited
DUCK or DIVE
Hope you’ve taken out travel insurance !
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Price-risk management instruments ..
• state intervention
• hold physical stocks
• forward contracts
• futures contracts
•
exchange traded
options
Copyright © 2005 JSE Limited
OPTIONS….another type of insurance!
Fire
Hail
R/TON
White Maize
PRICE RISK
Yellow Maize
DATE
Drought
Floods
Copyright © 2005 JSE Limited
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Futures vs Options
• as a buyer, fundamentally different risks
• buyer and seller of futures assume the same risk, and
face a legally binding obligation – margin requirements
• seller of an option has legally binding obligation if the
option is exercised
• buyer of an option has no legally binding obligation, BUT
to pay for the option (premium)
• the most a buyer of an option can lose is the price paid
for the option (the premium agreed on)
• the seller of an option is potentially exposed in the same
fashion as a futures contract (variation margin)
Copyright © 2005 JSE Limited
willing buyer\willing seller
• Two types of options:
– PUT options (floor price insurance)
A farmer would buy this instrument
– CALL options (ceiling price
insurance)
Millers interested in this insurance
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Buying floor price insurance….
• as a buyer of floor price insurance (PUT options)
you buy the RIGHT but not the obligation to sell
maize at an agreed floor price
• a seller of PUT options is OBLIGATED to buy your
product should you exercise your right
• the PUT option trade involves a willing
buyer\willing seller at an agreed premium for a
specific strike price
• the buyer can exercise the right to sell maize at
any time (American style options)
• the buyer pays premium (negotiated on market)
• seller receives the premium, but is margined by
the exchange to make sure that he can meet his
commitment
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Option terms ?
• Premium
the price you agree to pay for an option
• Strike price
the price at which you buy or sell the product
will be in R20 price intervals for APD
• Volatility
in simple terms it’s a measure of how fast or slow the
market is moving over a given time period regardless
of direction. In other words it tells what the probability
is of a price occurring within a certain time period
Copyright © 2005 JSE Limited
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When is your option worth something ?
• in-the-money: option which is made up of both
time and intrinsic value. In the case of a put
the strike price is above where the market is
trading
• at-the-money : the premuim consists of time
value and the strike price is near to the
current trading levels
• out-the-money :the premium is entirely time
premium. With puts the strike price is below
the market trading levels
Copyright © 2005 JSE Limited
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Illustration for Put Options
Current market
trading at R620
800 Put
In the money by
R180
720 Put
In the money by
R100
620 Put
At the money
580 Put
Out the money by
R40
400 Put
Out the money by
R220
Copyright © 2005 JSE Limited
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Premium costs
Bid
Offer
Jul WMAZ 660 P
2000 per contract ie
R20 per ton
2500
Jul WMAZ 700 P
4000
4800
Jul WMAZ 720 P
6000
6500
Jul WMAZ 780 P
8000
9000
The higher the floor price you want
the more it will cost you
Copyright © 2005 JSE Limited
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An producer example..no 1
• Farmer Brown would like to manage his price
risk using Put options:
– He buys a JulWMAZ 700 Put for R60 in Dec the
previous year
– In June when the option contract expires, the
underlying market is trading at R900…..
The put option expires worthless and he sells his
maize at R900 less the premium cost of R60,
therefore R840 Safex price, after hedging he still
makes an additional R140
Copyright © 2005 JSE Limited
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An producer example..no 2
• Farmer Brown would like to manage his price
risk using Put options:
– He buys a JulWMAZ 700 Put for R60 in Dec the
previous year
– In June when the option contract expires, the
underlying market is trading at R700…..
The put option expires at the money and no
option is automatically exercised. He can sell his
maize in the cash market for R700 less the
premium cost of R60, therefore R640 Safex price
as per his original hedge price
Copyright © 2005 JSE Limited
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An producer example..no3
• Farmer Brown would like to manage his price
risk using Put options:
– He buys a JulWMAZ 700 Put for R60 in Dec the
previous year
– In June when the option contract expires, the
underlying market is trading at R500…..
The put option expires in the money by R200, he
exercised his option and sells his maize at R700
less the premium cost of R60, therefore attaining
the R640 Safex price, by hedging he has achieve
a price which is R200 better then no hedge at all
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Buying options to manage price risk can only result
in a win-win situation, once you have decided
on the relevant strike price and paid the premium,
if it expires in the money you
have read the market well and
reap the rewards,
if it expires out the money you lose the
premium but can sell your product at a
higher market price
CJS (with sincere apologies)
Copyright © 2005 JSE Limited
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Buying ceiling price insurance….
• as a buyer of CALL options you buy the RIGHT
but not the obligation to BUY maize at an agreed
ceiling price
• a seller of CALL options is OBLIGATED to sell
you product should you exercise your right
• the CALL option trade involves a willing
buyer\willing seller at an agreed premium for a
specific strike price
• the buyer can exercise the right to BUY maize at
any time (American style options)
Copyright © 2005 JSE Limited
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Illustration for Call Options
Current market
trading at R620
400 Call
In the money by
R220
560 Call
In the money by
R80
620 Call
At the money
700 Call
Out the money by
R80
780 Call
Out the money by
R160
Copyright © 2005 JSE Limited
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Bid
Offer
Jul WMAZ 660 C
8000
8500
Jul WMAZ 700 C
6000
6500
Jul WMAZ 720 C
4000
4500
Jul WMAZ 760 C
2000
3000
The lower the ceiling price,
the higher the price (premium) of the option
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WITH THE HELP OF A
REGISTERED JSE
AGRICULTURAL BROKER, BE
GUIDED TO MAKE THE RIGHT
DECISIONS !
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Failure is an opportunity to begin
again, more intelligently – Henry
Ford
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