Buying (Going Long) Sugar Futures to Profit from a Rise in Sugar Prices

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Contents

Buying (Going Long) Sugar Futures to Profit from a Rise in Sugar Prices

If you are bullish on sugar, you can profit from a rise in sugar price by taking up a long position in the sugar futures market. You can do so by buying (going long) one or more sugar futures contracts at a futures exchange.

Example: Long Sugar Futures Trade

You decide to go long one near-month Euronext Raw Sugar (No. 408) Futures contract at the price of USD 0.1111 per pound. Since each Euronext Raw Sugar (No. 408) Futures contract represents 112000 pounds of sugar, the value of the futures contract is USD 12,443. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 1,456 to open the long futures position.

Assuming that a week later, the price of sugar rises and correspondingly, the price of sugar futures jumps to USD 0.1222 per pound. Each contract is now worth USD 13,688. So by selling your futures contract now, you can exit your long position in sugar futures with a profit of USD 1,244.

Long Sugar Futures Strategy: Buy LOW, Sell HIGH
BUY 112000 pounds of sugar at USD 0.1111/lb USD 12,443
SELL 112000 pounds of sugar at USD 0.1222/lb USD 13,688
Profit USD 1,244
Investment (Initial Margin) USD 1,456
Return on Investment 85.4615%

Margin Requirements & Leverage

In the examples shown above, although sugar prices have moved by only 10%, the ROI generated is 85.4615%. This leverage is made possible by the relatively low margin (approximately 11.7012%) required to control a large amount of sugar represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Hedging Against Rising Sugar Prices using Sugar Futures

Businesses that need to buy significant quantities of sugar can hedge against rising sugar price by taking up a position in the sugar futures market.

These companies can employ what is known as a long hedge to secure a purchase price for a supply of sugar that they will require sometime in the future.

To implement the long hedge, enough sugar futures are to be purchased to cover the quantity of sugar required by the business operator.

Sugar Futures Long Hedge Example

A beverage company will need to procure 11.20 million pounds of sugar in 3 months’ time. The prevailing 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 hedge against a rise in sugar price, the beverage company decided to lock in a future purchase price of USD 0.1100/lb by taking a long position in an appropriate number of Euronext Raw Sugar (No. 408) futures contracts. With each Euronext Raw Sugar (No. 408) futures contract covering 112000 pounds of sugar, the beverage company will be required to go long 100 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that the beverage company will be able to purchase 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 Rose by 10% to USD 0.1222/lb on Delivery Date

With the increase in sugar price to USD 0.1222/lb, the beverage company will now have to pay USD 1,368,752 for the 11.20 million pounds of sugar. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the sugar futures price will have converged with the sugar spot price and will be equal to USD 0.1222/lb. As the long futures position was entered at a lower price of USD 0.1100/lb, it will have gained 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 gain from the long futures position is USD 136,752.

In the end, the higher purchase price is offset by the gain in the sugar futures market, resulting in a net payment amount of USD 1,368,752 – USD 136,752 = USD 1,232,000. This amount is equivalent to the amount payable when buying the 11.20 million pounds of sugar at USD 0.1100/lb.

Scenario #2: Sugar Spot Price Fell by 10% to USD 0.1000/lb on Delivery Date

With the spot price having fallen to USD 0.1000/lb, the beverage company will only need to pay USD 1,119,888 for the sugar. However, the loss in the futures market will offset any savings made.

Again, 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 long futures position was entered at USD 0.1100/lb, it will have lost USD 0.1100 – USD 0.1000 = USD 0.0100 per pound. With 100 contracts covering a total of 11.20 million pounds, the total loss from the long futures position is USD 112,112

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the sugar futures market and the net amount payable will be USD 1,119,888 + USD 112,112 = USD 1,232,000. Once again, this amount is equivalent to buying 11.20 million pounds of sugar at USD 0.1100/lb.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the sugar buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising sugar prices while still be able to benefit from a fall in sugar price is to buy sugar call options.

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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

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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. ]

How to Trade Sugar CFDs

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Last Updated on November 5, 2020

4 Reasons You Might Invest in Sugar

Investors purchase soft commodities such as sugar for many reasons, but the following are most common:

  1. Speculation
  2. Inflation and Weak US Dollar Hedge
  3. Bet on Emerging Market Demand Growth
  4. Portfolio Diversification

Speculating on Sugar Prices

Most sugar production occurs in a few countries, and weather patterns play an important role in determining supply.

Sugar prices can be very volatile. Investors looking to speculate on short-term bottlenecks in supply might see sugar as an attractive investment.

How Does Sugar Act as an Inflation and Weak US Dollar Hedge?

Most commodity investments, including sugar, are priced in US dollars and, therefore, are a way to bet on a weak US dollar.

The US economy has relied disproportionately on consumer and government borrowing and spending over the past few decades. To incentivize borrowing, the Fed has kept interest rates low for a long period of time.

Growing debts and deficits in the United States could put pressure on the dollar and boost sugar and other commodity prices.

Betting on Emerging Market Demand Growth

Asian and other emerging economies are growing wealthier. As consumers in these countries accumulate more purchasing power, their appetite for sweet foods may grow as well. Investing in sugar might be a way to capitalize on these global trends.

Diversify Your Portfolio

Commodities such as sugar have historically had low correlations with stocks, bonds and other financial assets. Investing in sugar provides a way to diversify a portfolio and smooth out investment returns.

Should I Invest in Sugar?

Sugar is a volatile commodity, so investing in it could produce big gains or losses.

However, investing in sugar isn’t just for speculators. Commodities such as sugar can be a way to mitigate risk in an investment portfolio by providing asset diversification.

A basket of commodities that includes sugar, other soft commodities, metals and energy insulates a buyer from events that affect a particular commodity’s price.

Investing in sugar is also a way to profit from 3 long-term trends:

  1. Growing wealth in emerging markets could boost sugar consumption.
  2. Global warming trends could disrupt sugar production and lead to supply shocks.
  3. Demand for oil and gasoline could decline in the coming decades, and demand for ethanol could grow. Overconsumption of fossil fuels combined with heightened environmental concerns could hasten this trend and produce higher sugar prices.

Investing in sugar, however, has its risks including:

  1. Heightened concerns about a global obesity epidemic could curb demand.
  2. Strength in the US dollar could lead to weakness in commodities across the board.
  3. Increased government subsidies of sugar could produce an oversupply that dwarfs demand.
  4. Sugar substitutes such as aspartame and stevia could drive market demand away from sugar.
  5. Sugar is a volatile commodity that could move lower without any specific catalyst.

What Do the Experts Think About Sugar?

Experts see sugar and other soft commodities offering attractive investment opportunities in the coming years.

Shawn Hackett, President of Hackett Financial Advisors, believes that demand for sugar is strong and that the futures market suggests a rally might be coming soon.

Mike Ciccarelli, a commodity and stock trader at Briefing.com agrees. He believes that small changes in weather patterns could be the catalyst for a supply disruption and a rise in prices.

There’s minimal downside versus the potential for greater upside.

– Mike Ciccarelli, commodity and stock trader

The United States Department of Agriculture (USDA) notes lower supplies in China and Mexico could offset record production in the near future.

In sum, all of these experts see supply/demand imbalances favoring sugar prices in the future.

How Can I Invest in Sugar?

Sugar traders have several ways to invest in the commodity:

Sugar Trading Methods Compared

Leverage? Regulated Exchange? Sugar Futures 5 N N Y N Y Y Sugar Options 5 N N Y N Y Y Sugar ETFs 2 N N N Y N Y Sugar Shares 2 N N N N Y Y Sugar CFDs 3 N N N N Y Y

Sugar Futures

The New York Mercantile Exchange (NYMEX), which is part of the Chicago Mercantile Exchange (CME), and the Intercontinental Exchange (ICE) offer a contract on sugar that settles into 112,000 pounds of world sugar #11, which is the global benchmark for raw sugar.

The CME contract trades globally on the CME Globex electronic trading platform and has expiration months of March, May, July and October.

Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. At expiration, the contracts are financially settled on the NYMEX, but physically settled on the ICE.

Investing in futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.

Sugar Options on Futures

The ICE offers an options contract on sugar futures.

Options are also a derivative instrument that employ leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.

Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of sugar #11 futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in sugar futures to profit from their trades.

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Sugar ETFs

These financial instruments trade as shares on exchanges in the same way that stocks do. There are three popular ETFs that invest in sugar #11 futures:

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