Hedging Against Falling Sugar Prices using Sugar Futures

Sugar producers can hedge against falling sugar price by taking up a position in the sugar futures market.

Sugar producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of sugar that is only ready for sale sometime in the future.

To implement the short hedge, sugar producers sell (short) enough sugar futures contracts in the futures market to cover the quantity of sugar to be produced.

Sugar Futures Short Hedge Example

A sugar refinery has just entered into a contract to sell 11.20 million pounds of sugar, to be delivered in 3 months' time. The sale price is agreed by both parties to be based on the market price of sugar on the day of delivery. At the time of signing the agreement, spot price for sugar is USD 0.1111/lb while the price of sugar futures for delivery in 3 months' time is USD 0.1100/lb.

To lock in the selling price at USD 0.1100/lb, the sugar refinery can enter a short position in an appropriate number of Euronext Raw Sugar (No. 408) futures contracts. With each Euronext Raw Sugar (No. 408) futures contract covering 112,000 pounds of sugar, the sugar refinery will be required to short 100 futures contracts.

The effect of putting in place the hedge should guarantee that the sugar refinery will be able to sell the 11.20 million pounds of sugar at USD 0.1100/lb for a total amount of USD 1,232,000. Let's see how this is achieved by looking at scenarios in which the price of sugar makes a significant move either upwards or downwards by delivery date.

Scenario #1: Sugar Spot Price Fell by 10% to USD 0.1000/lb on Delivery Date

As per the sales contract, the sugar refinery will have to sell the sugar at only USD 0.1000/lb, resulting in a net sales proceeds of USD 1,119,888.

By delivery date, the sugar futures price will have converged with the sugar spot price and will be equal to USD 0.1000/lb. As the short futures position was entered at USD 0.1100/lb, it will have gained USD 0.1100 - USD 0.1000 = USD 0.0100 per pound. With 100 contracts covering a total of 11200000 pounds, the total gain from the short futures position is USD 112,112

Together, the gain in the sugar futures market and the amount realised from the sales contract will total USD 112,112 + USD 1,119,888 = USD 1,232,000. This amount is equivalent to selling 11.20 million pounds of sugar at USD 0.1100/lb.

Scenario #2: Sugar Spot Price Rose by 10% to USD 0.1222/lb on Delivery Date

With the increase in sugar price to USD 0.1222/lb, the sugar producer will be able to sell the 11.20 million pounds of sugar for a higher net sales proceeds of USD 1,368,752.

However, as the short futures position was entered at a lower price of USD 0.1100/lb, it will have lost USD 0.1222 - USD 0.1100 = USD 0.0122 per pound. With 100 contracts covering a total of 11.20 million pounds of sugar, the total loss from the short futures position is USD 136,752.

In the end, the higher sales proceeds is offset by the loss in the sugar futures market, resulting in a net proceeds of USD 1,368,752 - USD 136,752 = USD 1,232,000. Again, this is the same amount that would be received by selling 11.20 million pounds of sugar at USD 0.1100/lb.

Risk/Reward Tradeoff

As can be seen from the above examples, the downside of the short hedge is that the sugar seller would have been better off without the hedge if the price of the commodity went up.

An alternative way of hedging against falling sugar prices while still be able to benefit from a rise in sugar price is to buy sugar put options.

Learn More About Sugar Futures & Options Trading

Ready to Start Trading Futures?

Trade futures now at OptionsHouse.com with special low introductory contract rates!

To buy or sell futures, you need a broker that can handle futures trades.

OptionsHouse is a full fledged Futures Commission Merchant that provides a streamlined access to the futures markets at extremely reasonable contract rates.

Click here to open a futures trading account at OptionsHouse.com now!

You May Also Like

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

Follow Us on Facebook to Get Daily Strategies & Tips!

Sugar Options & Futures

Futures Basics

Softs Futures

Options Strategy Finder

Outlook on Underlying:

Profit Potential:

Loss Potential:


No. Legs:

Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.

Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2017. TheOptionsGuide.com - All Rights Reserved.