Orange juice is a personal favourite for many of us. So many people worldwide start their day with a refreshing glass of orange juice. It is a staple dietary presence across continents. It comes in various forms – freshly squeezed or bottled, sweetened or unsweetened and carbonated or regular. It is a nourishing drink for any time of the day and night, as an excellent mixer for various cocktails. But, unbeknownst to many, orange juice is also a popularly traded commodity in the financial markets.
Orange Juice in the finance world
However, trading in orange juice options is not a new phenomenon. It has been prevalent since 1966, when it started trading on the New York Cotton Exchange. Today, it is traded across various commodity exchanges and is a part of soft commodities. Apart from orange juice, several other agricultural commodities come under soft commodities. Examples of such other agricultural products are cotton, cocoa, coffee, rice, sugar and wheat.
Orange juice options trading has gained a strong foothold in commodity exchanges. It attracts various market participants such as farmers, food processors, storage houses, supply chain logistics, arbitrageurs, and speculators. A few select countries like Brazil, the United States and China produce the significant bulk of the crop used in orange juice production. These few markets are instrumental in determining international orange prices.
The impact of weather on orange juice
Like any other crop, oranges are also susceptible to the vagaries of weather and disease, amongst other things. Florida, which accounts for nearly half of the U.S. orange production, is prone to extreme weather events like hurricanes or unexpected cold waves. These erratic weather events tend to wipe out the entire season’s crop. Such unpredictability leads to price fluctuation in a shorter time frame. This unpredictability invites speculators to orange juice options. Also, at the same time, these contracts work as an excellent hedging tool for orange growers and other participants in the industry.
What is FCOJ?
Orange juice contracts ensure safeguards for businesses by mitigating the risks. Trading in orange juice is possible through futures and options. For orange juice trading, the underlying asset is FCOJ – Frozen Concentrated Orange Juice. A futures contract in the international market is 15,000 pounds of Concentrated Orange Juice Solids. Before 1950, orange juice consumption was mainly in freshly squeezed juice form. During the 1950s, the orange juice industry was revolutionized by the advent of technology to make FCOJ. This process has dramatically helped orange juice to become a popular drink world over.
With the increase in sales, farmers were encouraged to produce more oranges. But, due to the highly volatile prices, which resulted from unpredictable weather and various diseases affecting the crops, the farmers could not estimate the price of their crop, which would be ready in a few months. The FCOJ options came as a blessing for these orange producers to solve this pressing issue.
How to trade Orange Juice options?
A farmer who would expect his crop to be ready for sale in 6 months, but simultaneously, being unsure of the price he could get for his crop, the farmer now had an excellent tool to hedge or insure a reasonable price for his crop. The farmer could buy a put option in multiple lots equivalent to the size of his crop at a specific strike price and for a specific time frame. Now, all that the farmer needs to do here is invest a marginal amount in purchasing these put options. At the expiry of the contract, if the price in the international market has dropped considerably, the farmer remains protected as the put option gives him the right to sell his produce at the strike price he has determined.
On the other hand, if the trading price has moved up substantially at the expiry of the contract, the farmer can let his put option lapse and sell the oranges in the open market at a higher price. In such a scenario, all that the farmer loses is the premium paid for purchasing put options. This premium in the whole scheme would be only a marginal amount. So in a way, these put options work to ensure that the farmer comes out on top in any scenario, with just a marginal investment for purchasing the put option contract.
Can a manufacturer be protected as well?
Similarly, an orange juice manufacturer who may be concerned that the price of oranges may rise substantially in the coming months, thereby increasing his production cost, may safeguard his position by buying call options. This purchase can happen in multiple lots corresponding to his raw material requirement. The call options give the right to buy FCOJ at the predetermined price after a specific number of months. Here also, if the price substantially increases at the time of expiry of the option, then the manufacturer can invoke his right and buy the produce at the strike price determined for the call option. And in case the price decreases drastically at the time of expiry, then the manufacturer can let the OTM call option lapse and buy the oranges from the open market.
What factors affect orange juice prices?
Due to the above reasons, trading in FCOJ has become quite popular, and the volume in trading keeps increasing year on year. Prices of oranges are highly volatile due to diseases and weather disruptions. Often, government policies, local labour laws, and international trade development can also impact the supply chain of oranges. There have been instances whereby changes in consumption patterns in a particular country has also affected the orange prices. All these reasons have contributed significantly to the popularity of FCOJ trading in financial markets.
So we can see that orange juice options are a boon to all those involved in the trade. Due to their inherent nature of being highly volatile, they attract speculators, investors, and other participants to these financial instruments. Apart from all the trade people involved, the investors need to be aware of the weather patterns in the regions where this crop is grown and keep track of developments in local and international laws affecting the trade.
FCOJ options can add tremendous value to an investor’s portfolio who has adequate knowledge of the above factors.