Softs

Trading The Soft Commodity Markets

The soft markets are made up of cocoa, coffee, cotton, orange juice and sugar, some of the oldest commodities still around today. You can trace their roots in commerce back over thousands of years. It is important to note that trading in this market involves substantial risks and is not suitable for everyone, and only risk capital should be used. In this article, we'll show you how to use this "sweet" market properly, because any investor could potentially lose more than originally invested.

What are soft futures contracts?

A soft futures contract is a legally binding agreement for the delivery of cocoa, coffee, cotton, frozen concentrated orange juice and sugar in the future at an agreed upon price. The contracts are standardized by the ICE Futures U.S., previously known as New York Board of Trade (NYBOT), and regulated by the Commodity Futures Trading Commission, as to quantity, quality, time and place of delivery. Only the price is variable.

Most futures contracts are offset prior to delivery, meaning that most contracts are speculators trying to profit off of price movements.

Advantages of Futures Contracts

Unlike equities, futures contracts can be shorted on a downtick, which gives market participants greater flexibility. This flexibility allows hedgers to protect their physical position and speculators to take a position based on market expectations.

Because the soft commodity markets are traded at an exchange, the clearing services ensure no default risk. This means that the exchange acts as buyer to every seller should a market participant have to default on its responsibilities.

Market Personality

With the merger of the NYBOT and Intercontinental Exchange (ICE) in 2007, and after these markets went electronic, volume increased substantially.

Cotton

Because cotton has universal appeal and can be used in many different products, it has been one of more influential commodities. Discovered more than 5,000 years ago, cotton has played a vital role in the rise and fall of many countries. It was one of America's first cash crops.

Cotton is traded in 50,000-pound contracts. It is also traded in cents per pound, so if the market is trading at 53 cents per pound, the contract will have a value of $26,500 ($0.53 x 50,000 pounds = $26,500).

The minimum tick size is $0.0001 or $5 per contract. Therefore any 2 cent move in cotton will equate to either a gain or a loss of $1,000. When the price of cotton exceeds 95 cents per pound, the minimum tick movement will expand to $0.0005 to accommodate to the larger daily ranges.

March, May, July, October and December are the contract months for cotton. Delivery points are in Galveston, Houston, New Orleans, Memphis and Greenville/Spartanburg, which isn't too surprising considering that is where most of it is grown.

Sugar

It is widely believed that humans first used sugar well over 2,000 years ago. Originally only reserved for the very rich, sugar has become one of the more common staples on the dinner table. Because of its mass appeal, sugar is usually one of the most heavily traded commodities in the world in terms of total volume.

Sugar trades in contracts of 112,000 pounds as well as in cents per pound. If the futures price is $0.1045, the contract has a value of $11,704 ($0.1045/lb x 112,000 pounds = $11,704). If the market moves from $0.1000 to $0.1240, that is equivalent to a dollar move of $2,688.

The minimum price movement for sugar is $0.0001 or $11.20 per contract.

Sugar is only deliverable in March, May, July and October. There are delivery points in each nation where the sugar is produced. These are places like Argentina, Australia, Barbados, Belize, Brazil, Colombia, Costa Rica, Dominican Republic, El Salvador, Ecuador, FijiIslands, French Antilles, Guatemala, Honduras, India, Jamaica, Malawi, Mauritius, Mexico, Mozambique, Nicaragua, Peru, Republic of the Philippines, South Africa, Swaziland, Taiwan, Thailand, Trinidad, United States and Zimbabwe.

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Source: Investopedia