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BUYING SUGAR FUTURES
1. Based on the expectation of higher prices.
2. To establish costs, pre-determine selling prices and protect profits
on advance sales.
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Initial | | |
Transactions | Subsequent Transactions |Sugar Cost | Result
-------------+------+----------+--------+-------+------+------------+-------
| |Condition | Price |Result |Price | Figure it | In
| |of market | you | of | you | this way |each
| | when you | would |selling| pay | |case
| |buy actual| obtain | your | for | |the
| | sugar |for your|futures|actual| |same
| | |futures | |sugar | |
-------------+------+----------+--------+-------+------+------------+-------
| | | | | |Price paid |Your
| | | | | |for actual |sugar
| | | |A | |sugar less |cost is
You buy Sugar|When |If it has | |profit | |hedging |6.00
Futures at |you |advanced | |of | |profit |as pre-
6.00 to cover|buy |to 8.00 | 8.00 |2.00 | 8.00 |8-2=6 |deter-
future |actual| | | | | |mined
requirements;|sugar,| | |A | |Price paid |
fix your |you |If it has | |loss | |for actual |
price and |sell |declined | |of | |sugar plus |
take orders |your |to | | | |hedging loss|
on the basis |fu- |4.00 | 4.00 |2.00 | 4.00 |4+2=6 |
of 6c sugar |tures | | | | | |
| |If it is | |No | | |
| |still at | |profit,| | |
| |6.00 | 6.00 |no loss| 6.00 | 6.00 |
-------------+------+----------+--------+-------+------+------------+-------
It is equally clear that if a manufacturer names a price and takes
advance orders without pre-determining his sugar cost, his profit is a
matter of guesswork. He is not going to know the cost of his
manufactured product until he buys his sugar.
Assume that you have contracted to deliver sugar to a manufacturer or
to any customer at a definite date and a specified price, without
buying sugar to cover your requirements. If the price of sugar is
favorable when you deliver it, you are fortunate and net a profit. But
sugar may have advanced to a point where you are forced to pay such a
price that your profit is lower than it should be. In fact there may
not be any profit at all.
By conservative, wise use of the Sugar Exchange, most of this risk and
uncertainty can be eliminated and both you and your customer can go
ahead with your plans with your prices determined through a known sugar
cost.
Suppose that in March or April, for example, the market appears strong
and you find that some of your manufacturing customers are anxious to
be assured of an adequate supply of sugar at a definite price. In such
a case, if these advance orders called for a sufficient volume, and
provided Exchange prices were favorable, you could take care of your
trade's future requirements at a fixed price, without yourself taking a
speculative position. We also believe that buyers making these
arrangements with any of their trade would be justified in requesting
the same proportionate marginal protection which it is necessary for
jobbers themselves to give the seller on the Exchange. There will no
doubt be many occasions when it would be worth while to solicit orders
on this basis.
With your own sugar cost fixed by the use of the Exchange, you could
take proper care of these buyers without worrying about subsequent
fluctuations of the market, as you would know that your sugar cost
would be about the price paid for your futures which, let us say, is
6.00. (See Chart 4.)
The market may advance so that by September, sugar is selling at 8.00.
(You are now making deliveries to your trade as contracted). So you
sell your futures at 8.00, go into the market and buy actual sugar for
about the same figure, assuming, of course, that actual sugar has also
advanced in relative proportion, which is likely. You pay 2.00 more for
your actual sugar than you had figured but you have profited to the
extent of 2.00 on the sale of futures. Profit and loss cancel each
other and you have your sugar at 6.00. In other words, although the
market is now 8.00 you are delivering 6.00 sugar to your customers,
with a profit to yourself.
If the market declines after your original purchase at 6.00 so that in
September sugar is selling at 4.00, you will sell your futures at 4.00,
taking a loss of 2.00. But you will buy your actual sugar at about
4.00, also, which is 2.00 lower than you planned for. This gain of
2.00, while not to be termed an actual profit, may certainly be
considered as canceling the loss on the sale of your futures, so that
the cost of your sugar is really 6.00, your original price.
Another way of looking at this is to add the loss of 2.00 on the sale
of your futures to 4.00, the cost of your actual sugar, making 6.00,
the price upon which you had based your plans. If you had waited, you
would have been able to get your sugar for 4.00, but by buying it ahead
you have had the benefits of protection and the elimination of
speculation and risk.
If the market remains steady after your June purchase, or after various
fluctuations, returns to 6.00 by September, you sell your futures at
6.00 and buy spot sugar for about the same amount. Thus you have
neither gained nor lost, but you have been protected in your sugar
cost.
This is essentially a "playing-safe" operation. It results in profit
insurance for the jobber who is willing to sacrifice the possibility of
a speculative gain on advance sales to customers. It is thoroughly
sound business policy and is neither expensive nor difficult to carry
out.