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How to Trade Orange Juice Options

What Is Orange Juice Buying and selling?

Orange juice buying and selling has change into in style globally, and buying and selling volumes proceed to extend. Being one of many world’s hottest fruit juices, orange juice buying and selling attracts varied market members, together with farmers, processors, storage homes, market makers, and arbitrageurs. 

A number of monetary devices, like futures and choices, can be found for buying and selling orange juice. A futures contract is a authorized obligation to purchase or promote a commodity at a predetermined worth for supply on a particular date sooner or later. Futures contracts commerce on a futures exchange and are standardized, which means they’ve set quantities and supply dates.

However, an option contract provides the holder the suitable (however not the duty) to purchase or promote the underlying asset at a particular worth (referred to as a strike price) on or earlier than the contract’s expiration date (referred to as the expiry).

This text discusses choices buying and selling on orange juice contracts, buying and selling situations, orange juice buying and selling markets, participant profiles, dangers, rewards, and the way the figuring out components influence possibility costs for orange juice buying and selling. Orange juice choices on ICE futures exchange are taken as examples cited all through the article.

Key Takeaways

  • Orange juice buying and selling has change into in style globally, and buying and selling volumes proceed to extend. 
  • Orange juice buying and selling attracts varied market members, together with farmers, processors, storage homes, market makers, and arbitrageurs. 
  • A number of monetary devices, like futures and choices, can be found for buying and selling orange juice.
  • In orange juice choices buying and selling, the underlying asset is one FCOJ-A futures contract value 15,000 kilos of concentrated orange juice solids.

What Is an Orange Juice Choices Contract?

Soft commodities at the moment are discovering a spot in funding portfolios of market members as an alternate class of tradable securities. Comfortable commodities are usually agricultural merchandise which are purchased and bought by way of standardized contracts on commodities exchanges. Examples of soppy commodities embody:

  • Cotton
  • Cocoa
  • Espresso
  • Rice
  • Sugar
  • Wheat
  • Orange juice

Lack of storage and processing capabilities earlier than 1950 restricted orange juice to what was referred to as a same-day consumption commodity or a perishable commodity. Within the Nineteen Fifties, the orange juice trade was revolutionized by the event of frozen concentrated orange juice (FCOJ). By means of processing, freezing, and flavoring brokers, orange juice grew to become the world’s favourite fruit drink and the commodity that it’s right this moment. 

In orange juice choices buying and selling, the underlying asset is one FCOJ-A futures contract. One such futures contract is value 15,000 kilos of concentrated orange juice solids. Because of this if an orange juice possibility contract expires in-the-money (ITM), the customer of the orange juice call or put option will get the suitable to enter right into a long (purchase) or short (promote) orange juice futures contract.

The contract proprietor can take one in all a number of actions: commerce (promote/purchase) the futures contract, trade the contract for bodily orange juice or roll over the contract to the following time period futures contract.

Utilizing Orange Juice Choices for Hedging

Whereas market-making, arbitrage, and speculation proceed to stay the center of commodity buying and selling, hedging is the first goal for which so many merchandise proceed to get enabled for buying and selling on main world exchanges. Hedging is achieved by derivative merchandise like futures and choices that producers and shoppers can effectively use to realize risk management.

Put Possibility Hedge

Assume it’s January, and frozen concentrated orange juice is at the moment buying and selling at 135 cents/pound (the spot price). An orange farmer expects his crop (1 unit of FCOJ, or 15,000 kilos) to be prepared on the market by June (in six months). The farmer is nervous a couple of worth drop in oranges within the close to future, so he needs to safe the minimal sale worth of oranges (to say round 130 cents/pound) for when his crop is prepared. The farmer is searching for a hedge or worth safety on his crop. To do that, he should purchase one orange juice put possibility contract. 

A put possibility provides the farmer the suitable to promote the underlying asset at a specified promote (or strike) worth inside a particular timeframe. The orange farmer selects the choice contract with a strike worth of 135 cents and the expiry in June, which is when his crop will likely be prepared. He pays an upfront option premium of 4 cents per pound (4 cents X 15,000 kilos=$600).

Shopping for the put possibility will give the orange farmer the suitable, however not the duty, to take a brief place in a single orange juice futures contract on the predetermined worth of 135 cents on the time of the choice’s expiry. This futures contract will give him the suitable to promote the oranges at this predetermined worth (135 cents/pound X 15,000 kilos=$20,250). 

For simplicity, all of the examples famous above use one unit of frozen concentrated orange juice. Mentions of oranges or orange juice refer to 1 unit of frozen concentrated orange juice. Sensible calculations are supplied within the following sections.

Value of Orange Juice: Beneath the Put Strike Value 

If the value of orange juice declines to 110 cents per pound, the lengthy orange juice put possibility will come in the money. Because of this the strike worth is greater than the market worth, and subsequently the choice is value cash. The farmer will train the choice.

The farmer will get the brief futures place at 135 cents. He’ll acquire 25 cents/pound from the futures place (135 cents/pound – 110 cents/pound = 25 cents/pound). He paid the upfront possibility premium of 4 cents/pound taking his web revenue to 21 cents per pound. He can promote his orange juice on the market worth of 110 cents, taking the entire sale worth to 110 + 21 = 131 cents/pound. For a 15,000 kilos contract, he’ll obtain 15,000 * 131 cents = $19,650.

Value of Orange Juice: On the Put Strike Value

If the value of orange juice stays across the identical ranges (say at 133 cents) on the time of expiry, the choice will get exercised. He’ll get the brief futures contract at 135 cents and may sq. it off at 133 cents, giving him a revenue of two cents. He’ll promote his orange crop at market charges of 133 cents. Deducting the 4 cents he paid as possibility premium, his web sale worth is 131 cents/pound (133 + 2 – 4 = 131 cents/pound). For a 15,000 kilos contract, he’ll obtain $19,650.

Value of Orange Juice: Above the Put Strike Value

If the value of orange juice rises to, say, 150 cents on the time of expiry, the choice will expire nugatory (as the present worth is greater than the strike worth of the put possibility). The farmer won’t be able to train the choice and won’t get the brief futures contract.

Nevertheless, he’ll be capable to promote the orange crop at market charges of 150 cents per pound. Deducting the 4 cents he paid as possibility premium, his web sale worth will likely be 146 cents/pound (higher than his anticipated stage of 130 cents/pound). For a 15,000 kilos contract, he’ll obtain $21,900.

Advantages of Orange Juice Put Choices

Utilizing a put possibility of orange juice contracts has supplied the farmer with twin advantages in all of the doable situations. His danger is proscribed on the draw back with a assure of a minimal worth stage (131 cents) Plus, he can profit from the upward worth strikes. This comes at the price of the choice premium of 4 cents/pound.

Name Possibility Hedge

On the opposite facet, allow us to take into account an orange juice processor who should purchase one frozen concentrated orange juice unit in six months. The present worth of 1 unit of FCOJ is 135 cents. The processor is anxious that orange costs could rise, so he needs to restrict his buy worth to a most of about 140 cents/pound.

To achieve worth safety, the processor should purchase one orange juice name possibility. She selects an possibility with a strike worth of 135 cents and an expiry date of six months sooner or later. The upfront possibility premium value is 4.5 cents per pound (4.5 cents X 15,000 kilos = $675). On the time of expiry, this name possibility, if within the cash, will give her the suitable to take a protracted orange juice futures place which she will sq. off at current market charges to lock the purchase worth. 

Value of Orange Juice: Beneath the Name Strike Value

If the value of orange juice declines to 110 cents on the time of expiry, the choice will expire nugatory (as the present worth is decrease than the strike worth of a name possibility). The client won’t be able to train the choice and won’t get the lengthy futures contract.

Nevertheless, she is going to be capable to purchase the oranges on the market price of 110 cents per pound. Including the 4.5 cents per pound she paid as the decision possibility premium, her web purchase worth will likely be 114.5 cents per/pound (higher than his anticipated stage of 140 cents/pound). His web value will likely be 114.5 cents * 15,000 kilos = $17,175.

Value of Orange Juice: On the Name Strike Value

If the value of orange juice stays across the identical ranges (say at 137 cents/pound) on the time of expiry, the choice will get exercised (as the present worth is greater than the decision possibility’s strike worth).

The orange juice maker will get the lengthy futures contract at a predetermined 135 cents and may sq. it off at 137 cents, giving her a revenue of two cents/pound. She is going to purchase her oranges at market charges of 137 cents. Deducting the 4.5 cents she paid as possibility premium, the web purchase worth is 134.5 cents/pound (137 + 2 – 4.5 = 134.5 cents). His web value will likely be 134.5 cents * 15,000 kilos = $20,175.

Value of Orange Juice: Above the Name Strike Value

If the value of orange juice will increase to, say, 150 cents/pound, the lengthy orange juice name possibility will come within the cash and will likely be exercised. The client will get the lengthy futures place at 135 cents. She will sq. it off on the converging worth of 150 cents, as gaining (150 – 135) = 15 cents from the futures place.

She paid the upfront possibility premium of 4.5 cents, taking web revenue to 10.5 cents/pound. She will purchase oranges on the market worth of 150 cents, taking the entire purchase worth to 139.5 cents/pound (150 – 10.5 = 139.5 cents/pound). His web value will likely be 139.5 cents * 15,000 kilos = $20,925.

Advantages of Orange Juice Name Choices

On this case, utilizing orange juice choices ensures a most capped purchase worth in all situations, with the good thing about decrease purchase worth in case of market worth declines. By paying a fraction of the associated fee within the type of an possibility premium, the producer and shopper can successfully shield the draw back danger and but maintain the upward revenue/saving potential excessive.

Aside from hedging situations, merchants actively make speculative bets on orange juice contracts to learn from worth modifications and arbitrage alternatives. Market Makers additionally make an necessary contribution by providing ample liquidity and tight spreads within the choices market.

Orange Juice Choices vs. Orange Juice Futures

Ideally, both futures or choices can be utilized for hedging, hypothesis, or arbitrage. Nevertheless, a transparent benefit lengthy choices have over futures is that lengthy possibility positions don’t want margin cash or a day by day mark-to-market like futures. This comfort comes at the price of a nonrefundable possibility premium being paid upfront and is vulnerable to time decay. Brief choices do require margin capital.

Lengthy choices additionally restrict the losses (capped to possibility premium paid), whereas futures have limitless loss potential on each lengthy and brief positions.

The Orange Juice Choices Buying and selling Market

Futures buying and selling in frozen concentrated orange juice began in 1945 and is claimed to be one of many causes for oranges taking one of many high spots in U.S. crops. At present, frozen concentrated orange juice futures contracts commerce on the ICE exchange. The bodily settlement of 1 contract equal to fifteen,000 kilos of orange solids is completed by supply in drums or tanks. Allowed international locations of origin for oranges are the USA, Brazil, Costa Rica, and Mexico.

Brazil tops the orange-producing nation’s record, adopted by China after which the USA as of 2021. These three international locations are probably the most influential markets for figuring out worldwide orange costs. For the 2019-20 rising 12 months, round 55 p.c of U.S. oranges come from Florida, the place the crop is vulnerable to excessive climate occasions like hurricanes or sudden chilly snaps that may wipe out the complete season’s crop.

The focus of many of the crop in a single location and the chances of utmost climate occasions and related situations in Brazil have led to excessive uncertainty and therefore excessive volatility in orange costs. This volatility is mirrored in orange choices valuations.

Right here is the volatility graph as obtainable from the ICE trade report:

Such various volatility results in excessive volatility skew, which makes orange juice possibility contracts appropriate to commerce ratio spreads. Ratio spreads utilizing choices match these devices, which have excessive volatility skew (i.e., excessive ranges of variations in volatility between ITM, ATM, and OTM choices). 

The ICE Change has FCOJ A choices obtainable for buying and selling throughout the cities of New York, London, and Singapore, ideally masking all geographical places throughout APAC, Europe, and the USA in the course of the 24-hour cycle.

What Impacts Orange Costs and Choices Valuations?

Any agricultural commodity is affected by climate and illness. Oranges are not any exception. In truth, most oranges for orange juice are grown in three places, Florida, Mexico, and Brazil. Because of this an excessive climate or illness occasion in a single location can disturb and even destroy an enormous quantity of worldwide FCOJ provide. Hurricanes and unseasonable freezing and frosts influence these areas. Brazil additionally suffers from droughts from Might to June, which might have an effect on the orange crop. These climate occasions influence the orange crop, which impacts FCOJ costs and choices costs.

Orange juice choices merchants should pay shut consideration to seasons and climate forecasts. Hurricane forecasts may end up in steep worth rises as merchants anticipate injury to the orange crop. As soon as the hurricane passes, costs will modify to replicate the precise injury suffered by the crop. In anticipation of the winter freeze damaging the orange crop and decreasing provide, costs usually go up in November. This worth spike can reverse in December and January as soon as the extent of freeze injury turns into evident. The ICE trade report  supplies the next illustration:

Merchants also needs to concentrate on how modifications in consumption habits can have an effect on orange juice costs. A rise in consumption within the nation the place the oranges are grown may scale back the export provide. Customers may cease viewing orange juice as a well being drink and transfer on to different drinks, as has been occurring in the USA. The discount in consumption can result in worth declines.

Authorities insurance policies, native labor legal guidelines, and worldwide commerce developments can influence orange manufacturing and provide. The orange and orange juice demand and provide report from the U.S. Division of Agriculture covers estimates throughout all orange-producing areas in the USA and overseas. Orange juice choices merchants also needs to comply with associated information gadgets particular to orange juice buying and selling from the favored market and information knowledge suppliers.

To commerce orange juice choices, one wants a commodity buying and selling account with regulated brokers who’ve approved membership with the respective trade.

The Backside Line

Curiosity and diversification necessities have led to merchants wanting past the odd safety lessons of equities, bonds, and plain-vanilla commodities. Orange juice has been a extremely risky gentle commodity lately, making it a high-risk buying and selling asset.

Aside from the above-listed components that have an effect on the orange spot costs, orange juice possibility buying and selling can be impacted by components particular to possibility pricing fashions—exercise or strike worth, time to expiryrisk-free rate of return (rate of interest), and volatility.

Orange juice possibility merchants ought to concentrate on these dependencies. Buying and selling orange juice choices is advisable just for skilled merchants who’ve ample information in choices buying and selling.

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