copyright © 2005 jse limited the agricultural products division of the jse agricultural derivatives...

Copyright © 2005 JSE Limited

The Agricultural Products Division of the JSE

Agricultural Derivatives

101

Copyright © 2005 JSE Limited 2.

Agriculture in South Africa

• 3,5 – 4,0% contribution to GDP (but 40% of population dependant on agriculture)

• 10% of South African exports (by value)• Major agric export earner = sugar (maize, wine, fruit)• Farmers: 50 000 commercial

240 000 small scale farmers3m subsistence farmers

• 13% of South Africa is arable land (only 20% is high potential)

• Major limiting resource is WATER• RSA = 6% of African population

4% of African land area25 – 30% of maize produced in Africa

10% of wheat produced in Africa 50 – 60% of maize produced in SADC


Agriculture in South Africa

• 1930 – early 90’s Regulated MarketingCentralized marketingCentralized price determination

• 1995 Agricultural market deregulatedControl Boards / Marketing Boards scrapped

NO centralized price determination

Agricultural marketing inAgricultural marketing in South Africa South Africa is a whole is a whole new ball gamenew ball gamein a deregulated in a deregulated market placemarket place

Agricultural marketing inAgricultural marketing inSouth Africa South Africa is a whole is a whole new ball gamenew ball gamein a deregulated in a deregulated market placemarket place


Agricultural Markets

• RegulatedAdvantages: No price risk

Information supply Disadvantages: Cost to economy

Distortion to economy

• Free Market Disadvantages: Price Risk

InformationUnfair Competition

Advantages: OpportunitiesEconomic Basis


Challenges of the Free Market

• Unfair Competition – not level playing field

• One sided – inputs / outputs (no link)• Requires decisions• Requires sourcing and interpretation of

information• Does not respect tradition or history• Makes use of technological progress


Background to Derivatives

• Mesopotamia, China, France, USA - agriculture• Fluctuating Prices depending on supply and

demand of product• Forward Contracts• Standardized Forward Contracts to facilitate

trading• Add guarantee to the market• Futures Contracts• Financial Markets


A futures market is...

• A trading operation that provides market participants with a price determination mechanism and a price risk management facility through which they can manage their exposure to adverse price movements on the underlying physical market and where performance by both counterparties to the contract is guaranteed


It is It is NOTNOT a “get rich quick” a “get rich quick” schemescheme


……. it is to avoid . it is to avoid losinglosing money! money!


The Agricultural Derivatives Market in South Africa

• Establishment of the South African Futures Exchange (SAFEX) in 1988 to trade financial derivative instruments

• Establishment of the Agricultural Markets Division of SAFEX in 1995 separate membership

start-up capital raised by the issue of seats• Initial futures contracts (chilled beef and potatoes) not successful• White and yellow maize contracts listed in 1996• August 2001 - became Agricultural Products Division of the JSE

Securities Exchange South Africa• Presently trade maize, wheat, sunflower seeds and soyabean

futures and options contracts• Recognised as the price discovery facility for grains in South and

Southern Africa


futures contracts .....futures contracts .....

• standardised agreement through exchangestandardised agreement through exchange

(product, quality, quantity, time & place)(product, quality, quantity, time & place)

• indirect locked-in priceindirect locked-in price• physical delivery not impliedphysical delivery not implied• profit / loss profile exactly opposite to physical profit / loss profile exactly opposite to physical

marketmarket• basis riskbasis risk• margins payablemargins payable


WHY use a futures market WHY use a futures market ??

..........for two very good reasons !..........for two very good reasons !

• price determinationprice determination andand

• price-risk managementprice-risk management


Maize Price determinants

• South African Demand and Supply- role of weather

- input suppliers- crop

estimates committee• Regional Demand and Supply

- actual economic demand ?• International Demand and Supply• Exchange Rates


Price determination ......

• futures exchanges do not set futures exchanges do not set prices,prices,

they are free markets where the they are free markets where the forces that influence prices, forces that influence prices, notably supply and demand, are notably supply and demand, are brought together in a transparent brought together in a transparent way.way.


How are prices determined?How are prices determined?

by brokers representingby brokers representingclients who trade on aclients who trade on atrading floor (pit) or trading floor (pit) or electronically onelectronically ona trading screen -a trading screen -

the trading screenthe trading screenreflects the best bidsreflects the best bids(highest) and offers(highest) and offers(lowest).(lowest).


JAN 96 BEEF FUTURES CONTRACT

6.75

7.25

7.75

8.25

8.75

9.25

9.75

O N D J

NABI

JAN FUTURE


July 04 White Maize

800

900

1000

1100

1200

1300

1400

1500

1600

1700

DATE

R/T

ON


July 05 White Maize

400

500

600

700

800

900

1000

1100

1200

1300

2004

/06/

10

2004

/06/

24

2004

/07/

08

2004

/07/

22

2004

/08/

05

2004

/08/

19

2004

/09/

02

2004

/09/

16

2004

/09/

30

2004

/10/

14

2004

/10/

28

2004

/11/

11

2004

/11/

25

2004

/12/

09

2004

/12/

23

2005

/01/

06

2005

/01/

20

2005

/02/

03

2005

/02/

17

2005

/03/

03

2005

/03/

17

2005

/03/

31

2005

/04/

14

Date

R/T

on

Realization of large carry over and good planting possibilities

Possibility to lock in prices of +/- R1000/t


July 06 White Maize

600

650

700

750

800

850

900

950

29/0

3/20

05

05/0

4/20

05

12/0

4/20

05

19/0

4/20

05

26/0

4/20

05

03/0

5/20

05

10/0

5/20

05

17/0

5/20

05

24/0

5/20

05

31/0

5/20

05

07/0

6/20

05

14/0

6/20

05

21/0

6/20

05

28/0

6/20

05

05/0

7/20

05

12/0

7/20

05

19/0

7/20

05

26/0

7/20

05

02/0

8/20

05

09/0

8/20

05

16/0

8/20

05

23/0

8/20

05

30/0

8/20

05

06/0

9/20

05

13/0

9/20

05

20/0

9/20

05

27/0

9/20

05

04/1

0/20

05

11/1

0/20

05

18/1

0/20

05

25/1

0/20

05

Date

R/T

on

Where to next ??


SAFEX nearby White Maize (R/t) since 1998

400.00

500.00

600.00

700.00

800.00

900.00

1000.00

1100.00

1200.00

1300.00

1400.00

1500.00

1600.00

1700.00

1800.00

1900.00

2000.00

2100.00

2200.00

2300.00

01/05/1998

29/5/98

21/10/98

15/3/99

08/11/1999

01/06/2000

06/01/2000

24/10/2000

19/03/2001

16/08/2001

11/01/2002

10/06/2002

31/10/2002

28/03/2003

22/08/2003

19/01/2004

14/06/2004

04/11/2004

31/03/2005

24/08/2005

Date

R/T

on


Price-risk management Price-risk management instrumentsinstruments .. ..

• state interventionstate intervention• hold physical stockshold physical stocks• forward contractsforward contracts• futures contractsfutures contracts• optionsoptions

To hedge or not to hedge,that is the question!

Whether it is better for farmers in the production of maize

to suffer the ups and downs ofoutrageous maize prices, or totake precautions against a sea

of uncertainty and by managingprice risk, end the uncertainty.

RMGB (with apologies)


Guarantee in Market

• Structure of the market• Margin Payments

- initial margin- variation margin


Clearing Member Clearing Member

Broker Trade Broker

Client A Client XClient B Client YClient C Client Z

Clearing House

Structure of the Exchange


Margin Flows Date Contract Contract Action Seller’s Buyer’s price value acc. acc.

8/3 R550 R55000 init. margin R10000 R10000

11/3 R545 R54500 var. margin R10500 R500 R10000

(R500)

12/3 R547 R54700 var. margin R10300 R200 R10200

15/3 R540 R54000 var. margin R11000 R700 R10000 (R500)

17/3 R520 R52000 var. margin R13000 R2000R10000 (R2000)

18/3 R510 R51000 var. margin R14000 R1000 R10000 (R1000)

Seller receives margin R10000 plus profit R4000 (R550-R510 x 100) from the futures market and R510/t from the physical market. Buyer receives margin R10000, but has lost R4000 (which as a hedger will be compensated for by a lower physical purchase cost: R510/t).


...... by using the futures market ...... by using the futures market individuals, companies or countries individuals, companies or countries selling or buying a commodity can selling or buying a commodity can protect themselves against price protect themselves against price movements in the underlying physical movements in the underlying physical market. This is achieved by selling or market. This is achieved by selling or buying futures or options contracts buying futures or options contracts through a broker who is a member of through a broker who is a member of the futures exchange.the futures exchange.


Requirements for a Successful Agric Futures Market

• Liquidity in underlying spot market (volume of production, multiple buyers and multiple sellers)

• Commodity must be able to be standardized• Price must be volatile (must be a need for price risk

management)• No state intervention in the price making mechanism• Guaranteed contract performance (clearing & financial

system)• Deliverability (infrastructure / grading regulations /

warehouse receipts)


Growth of the Market...


Total contracts traded – futures and options

0

500000

1000000

1500000

2000000

2500000

1998 1999 2000 2001 2002 2003 2004

Co

ntr

acts

Futures Options


Physical delivery in completion of a futures

contract….


Delivery starts at the silo ….


Why allow for physical delivery on the futures market.

• no underlying cash market to base prices off– therefore no cash index available to settle the

futures contract

• guaranteed delivery to the buyer of a Safex silo receipt representing good delivery

• guaranteed payment to the seller• standardisation of the contract is required

(quantity, quality, place, storage)


• physical delivery is a two day process on Safex, first the notice day followed by the delivery day

• delivery can take place anytime during the delivery month ie May

• commodity is deliverable all months of the year, five main hedging months with the remainder as constant delivery months

• short position holder gives notice any time during the delivery month

• long position holder is randomly allocated commodity as deliveries are received

Delivery onto Safex….


DECEMBER 2004

M T W T F S S

30 1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30 31

30

30

1

31

21


Initial margin requirements

• Contracts traded before delivery require R10000 for white and yellow maize,

• Extended price limits margins increase• on the first delivery day margins move to

R13000 per contract and price limits removed,

• from last trading day to expiry, margins are increased to R23000 per contract,


• A short futures position is required in the particular delivery month before any notice can be tendered

• Short position holder tenders notice through his broker– the following information is required

• silo receipt number• quantity• location• date storage is paid to

• Delivery notice is faxed/emailed to Safex before 12h45 on notice day

Detail required for delivery…


Copy of a delivery notice SAFEX DELIVERY NOTICE WHITE MAIZE FUTURES CONTRACT JSE VAT REGISTRATION NUMBER: 4080119391 TAX INVOICE NUMBER: WMAZ286

The undersigned short position holder hereby give notice to the Clearing House of intention to deliver as follows:

Delivery Notice Ref WMAZ286

SHORT POSITION HOLDER ClientCode xyz19 MemberCode TTT ClearingMemberCode STDC

NoticeDate 08-Jul-03 DeliveryDate 09-Jul-03 FuturesContract JUL 2003 WMAZ NumberOfContracts 46 QuantityTons 4600

Receipt Quantity Silo Silo Storage Days Storage Due Loc Diff Discount PerTon TotalDiscount Number Owner Location Paid To Storage Per Ton PerTon 808163 200 SWK Schuttesdraai 07-Jul-03 2 0.62 67 67.62 13524 806232 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806200 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806219 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806245 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 795444 100 SWK Werda 27-Jun-03 12 3.72 63 66.72 6672 793299 100 SWK Mirage 20-Jun-03 19 5.89 62 67.89 6789 792271 100 SWK Buckingham 12-Jun-03 27 8.37 42 50.37 5037 791772 100 SWK Vierfontein 18-Jun-03 21 6.51 57 63.51 6351 TOTAL DISCOUNT R300,293.00 For Clearing House use only: CLOSING FUTURE'S PRICE ON DAY PRIOR TO DELIVERY DAY R852.00 GROSS INVOICE AMOUNT R3,919,200.00 NET INVOICE AMOUNT DUE TO SHORT POSITION HOLDER -------------------- R3,618,907.00 -------------------- --------------------

AGRICULTURAL PRODUCTS DIVISION A DIVISION OF THE JSE SECURITIES EXCHANGE One Exchange Square Gwen Lane Sandown

Delivery Notice WMAZ286 Page 1 of 1


Copy of a assignment notice SAFEX ASSIGNMENT NOTICE WHITE MAIZE FUTURES CONTRACT JSE VAT REGISTRATION NUMBER: 4080119391 TAX INVOICE NUMBER: WMAZ286

The undersigned short position holder hereby give notice to the Clearing House of intention to deliver as follows:

Delivery Notice Ref WMAZ286

SHORT POSITION HOLDER ClientCode CYH20 MemberCode ABL

ClearingMemberCode VKSC

NoticeDate 08-Jul-03 DeliveryDate 09-Jul-03 FuturesContract JUL 2003 WMAZ NumberOfContracts 46 QuantityTons 4600

Receipt Quantity Silo Silo Storage Days Storage Due Loc Diff Discount PerTon TotalDiscount Number Owner Location Paid To Storage Per Ton PerTon 808163 200 SWK Schuttesdraai 07-Jul-03 2 0.62 67 67.62 13524 806232 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806200 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806219 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 806245 1000 SWK Werda 01-Jul-03 8 2.48 63 65.48 65480 795444 100 SWK Werda 27-Jun-03 12 3.72 63 66.72 6672 793299 100 SWK Mirage 20-Jun-03 19 5.89 62 67.89 6789 792271 100 SWK Buckingham 12-Jun-03 27 8.37 42 50.37 5037 791772 100 SWK Vierfontein 18-Jun-03 21 6.51 57 63.51 6351 TOTAL DISCOUNT R300,293.00 For Clearing House use only: CLOSING FUTURE'S PRICE ON DAY PRIOR TO DELIVERY DAY R852.00 GROSS INVOICE AMOUNT R3,919,200.00 NET INVOICE AMOUNT DUE TO SHORT POSITION HOLDER -------------------- R3,618,907.00 -------------------- --------------------

AGRICULTURAL PRODUCTS DIVISION A DIVISION OF THE JSE SECURITIES EXCHANGE One Exchange Square Gwen Lane Sandown

Delivery Notice WMAZ286 Page 1 of 1


• broker will deliver silo receipt by 12h00 on the delivery day

• silo receipt has to be signed off• payment is finalised by 12h00 on delivery day• buyer’s broker can pick up silo receipt from

14h00 on delivery day• initial margin to both buyer and seller will be

returned the following day

Settlement as follows…


Lets step outside for some refreshments…..


Welcome back !

Lets look at your “OPTIONS”


DUCK or DIVE

Hope you’ve taken out travel insurance !


Price-risk management Price-risk management instrumentsinstruments .. ..

• state interventionstate intervention• hold physical stockshold physical stocks• forward contractsforward contracts• futures contractsfutures contracts

• exchange traded exchange traded optionsoptions


DATE

R/T

ON

White Maize

Yellow Maize

PRICE RISK

OPTIONS….another type of insurance!

Fire

Drought Floods

Hail


Futures vs OptionsFutures vs Options

• as a buyer, fundamentally different risks• buyer and seller of futures assume the same risk, and

face a legally binding obligation – margin requirements• seller of an option has legally binding obligation if the

option is exercised• buyer of an option has no legally binding obligation, BUT

to pay for the option (premium)• the most a buyer of an option can lose is the price paid

for the option (the premium agreed on)• the seller of an option is potentially exposed in the same

fashion as a futures contract (variation margin)


willing buyer\willing seller

• Two types of options:

– PUT options (floor price insurance)

A farmer would buy this instrument

– CALL options (ceiling price insurance)

Millers interested in this insurance


Buying floor price insurance….• as a buyer of floor price insurance (PUT options) you

buy the RIGHT but not the obligation to sell maize at an agreed floor price

• a seller of PUT options is OBLIGATED to buy your product should you exercise your right

• the PUT option trade involves a willing buyer\willing seller at an agreed premium for a specific strike price

• the buyer can exercise the right to sell maize at any time (American style options)

• the buyer pays premium (negotiated on market)• seller receives the premium, but is margined by the

exchange to make sure that he can meet his commitment


Option terms ?

• Premium- the price you agree to pay for an option

• Strike price the price at which you buy or sell the product

will be in R20 price intervals for APD• Volatility

in simple terms it’s a measure of how fast or slow the market is moving over a given time period regardless of direction. In other words it tells what the probability is of a price occurring within a certain time period


• in-the-money: option which is made up of both time and intrinsic value. In the case of a put the strike price is above where the market is trading

• at-the-money : the premuim consists of time value and the strike price is near to the current trading levels

• out-the-money :the premium is entirely time premium. With puts the strike price is below the market trading levels

When is your option worth something ?


Illustration for Put Options

800 Put In the money by R180

720 Put In the money by R100

Current market trading at R620

620 Put At the money

580 Put Out the money by R40

400 Put Out the money by R220


Bid Offer

Jul WMAZ 660 P 2000 per contract ie R20 per ton

2500

Jul WMAZ 700 P 4000 4800

Jul WMAZ 720 P 6000 6500

Jul WMAZ 780 P 8000 9000

The higher the floor price you want The higher the floor price you want

the more it will cost youthe more it will cost you

Premium costs


An producer example..no 1

• Farmer Brown would like to manage his price risk using Put options:– He buys a JulWMAZ 700 Put for R60 in Dec the

previous year– In June when the option contract expires, the

underlying market is trading at R900…..

The put option expires worthless and he sells his maize at R900 less the premium cost of R60, therefore R840 Safex price, after hedging he still makes an additional R140


An producer example..no 2




The put option expires at the money and no option is automatically exercised. He can sell his maize in the cash market for R700 less the premium cost of R60, therefore R640 Safex price as per his original hedge price


An producer example..no3




The put option expires in the money by R200, he exercised his option and sells his maize at R700 less the premium cost of R60, therefore attaining the R640 Safex price, by hedging he has achieve a price which is R200 better then no hedge at all


Buying options to manage price risk can only result in a win-win situation, once you have decided

on the relevant strike price and paid the premium, if it expires in the money you have read the market well and

reap the rewards, if it expires out the money you lose the premium but can sell your product at a

higher market price CJS (with sincere apologies)


Buying ceiling price insurance….

• as a buyer of CALL options you buy the RIGHT but not the obligation to BUY maize at an agreed ceiling price

• a seller of CALL options is OBLIGATED to sell you product should you exercise your right

• the CALL option trade involves a willing buyer\willing seller at an agreed premium for a specific strike price

• the buyer can exercise the right to BUY maize at any time (American style options)


Illustration for Call Options

400 Call In the money by R220

560 Call In the money by R80

Current market trading at R620

620 Call At the money

700 Call Out the money by R80

780 Call Out the money by R160


Bid Offer

Jul WMAZ 660 C 8000 8500

Jul WMAZ 700 C 6000 6500

Jul WMAZ 720 C 4000 4500

Jul WMAZ 760 C 2000 3000

The lower the ceiling price, The lower the ceiling price,

the higher the price (premium) of the optionthe higher the price (premium) of the option


WITH THE HELP OF A REGISTERED JSE AGRICULTURAL BROKER, BE GUIDED TO MAKE THE RIGHT DECISIONS !


Failure is an opportunity to begin again, more intelligently – Henry

Ford

copyright © 2005 jse limited the agricultural products division of the jse agricultural derivatives...

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