What it means
A futures contract is an agreement to buy or sell a set quantity of a commodity at a fixed price on a future date. This contract covers raw cane sugar, which is the unrefined product that refineries buy and turn into white sugar for consumers and food manufacturers.
The contract is widely followed because it gives a transparent world price for raw sugar. Prices respond to the size of crops in major producing countries, weather, energy prices, because sugar cane can be used to make ethanol, currencies and demand from food and beverage makers.
Businesses use the contract in two ways. A producer can sell futures to lock in a price for its coming harvest, while a confectionery or beverage maker can buy futures to protect itself against rising ingredient costs.
This is called hedging, and it reduces uncertainty in budgets. Speculators also trade the contract, hoping to profit from price moves, and their trading adds liquidity (the ability to buy or sell easily).
Most contracts are closed out before delivery, though the contract does allow physical delivery of raw sugar in specified months. Reading the price takes some care.
The quote is in cents per pound for a standard contract, so a move from 20.00 to 20.50 cents is half a cent per pound, which is $560 on one contract. Traders and finance teams convert between the quote and dollars so that the effect on budgets is clear.
Because the contract is traded with margin, a small deposit controls a large amount of sugar. That magnifies both gains and losses, so participants must monitor positions daily and be ready to add funds if the price moves against them.
In practice
Real-world examples.
Example
A sugar mill in a producing country sells futures to fix the price of part of its next harvest. If prices fall, the gain on the futures offsets the lower price received for the physical sugar. The mill chooses how much of the crop to hedge, usually a portion, to keep some benefit if prices rise.
Example
A chocolate maker buys futures to lock in its sugar costs for the next year. The finance team uses the locked-in price when setting product prices and the annual budget. The treasurer reports the hedge position to the board every quarter.
Example
A commodity fund buys contracts because it expects poor weather to cut supply. It uses stop-loss orders to limit losses if the market moves the other way. The fund also limits the number of contracts to keep any one loss within its risk budget.
Formula
Calculation
Contract value = Price in cents per pound / 100 x 112,000 pounds
Profit or loss = (Exit price - Entry price) / 100 x 112,000 for a long position
A trader buys one contract at 20.00 cents per pound. The contract value is 20.00 / 100 x 112,000 = 0.20 x 112,000 = $22,400. If the price rises by 1.5 cents to 21.50, the gain is 0.015 x 112,000 = $1,680, and a one-tick move of 0.01 cent is worth 0.0001 x 112,000 = $11.20.Case study
Seen in the real world.
Sweetbay Confectionery is an illustrative, fictional company that uses about 5,600,000 pounds of raw-equivalent sugar a year. Its finance director worried that a price rise would erode the margins on its main product line.
She bought 25 Sugar No. 11 contracts to cover about half of the year's needs, since 25 contracts of 112,000 pounds is 2,800,000 pounds. When the market later rose by 4 cents per pound, the futures gained 0.04 x 2,800,000 = $112,000, which offset most of the higher cost of the physical sugar.
In this illustrative story, the company's profit for the year was stable even though sugar prices had been volatile. The finance director also noted that the hedge worked in both directions, because if prices had fallen the company would have lost on the futures but paid less for its sugar.
Watch out
Common mistakes.
- Confusing Sugar No. 11, which is raw cane sugar, with Sugar No. 5, which is a white sugar contract traded in London.
- Forgetting that the price is quoted in cents per pound, not dollars.
- Using futures without planning for margin calls, which can drain cash when prices move against the position.
Questions
People also ask.
What is the contract size?
One Sugar No. 11 contract covers 112,000 pounds, which is 50 long tons, and it is the standard unit of trading in the market.
What is the minimum price move?
The minimum fluctuation is 0.01 cent per pound, which equals $11.20 per contract.
Do I have to take delivery of sugar?
No, most participants close their position before expiry, although physical delivery is possible in the delivery months, so anyone holding a contract near expiry should check the exchange rules.
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