Buying Coffee Call Options to Profit from a Rise in Coffee Prices

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect Choice For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Only For Experienced Traders!

The Cost of a Cup of Coffee: Where Does the Money go?

Over the past few years, the specialty coffee industry has experienced a fluctuating market with coffee prices trading slightly higher than traditionally expected. A shift in the price of coffee also affects the price of the finished cup, which has led even major cafe chains to increase their menu pricing. For consumers, the increase can be a bit confusing—a cursory look at the futures market shows coffee trading around $1.75 per pound, but when a consumer purchases a pound of coffee from their favorite roaster, they are paying $9-$12 per pound. So where is all the money going?

According to Ric Rhinehart, Executive Director of the Specialty Coffee Association of America, it turns out the money being made is not in the price difference between a pound of green coffee and a pound of roasted coffee. Instead, there are a lot of smaller moving pieces that make up the overall cost in a cup of coffee.

The calculation for any cup of coffee starts at the farm gate. Typical expenses at origin include labor, fertilizer, inspections, certifications (Organic, Rainforest Alliance, Fair Trade), transportation, and membership fees (if the producer is part of a cooperative). While the costs incurred by farmers are relatively easy to identify, they can vary dramatically based on the size and location of the farm and type of coffee the farmer is producing. This makes it challenging to calculate how much it actually costs to produce an average pound of green coffee at origin.

Once the coffee has been harvested, processed, put under contract by exporters, and transferred to importers, it moves on to the roaster. Roasters take on the actual cost of coffee: the agreed-upon purchase price per pound negotiated with the contract holder, as well as any add-ons, like import/export fees and transportation. During the actual roasting process, coffee has about 18 percent loss or shrinkage, so that pound of green coffee ends up as .82 lbs of roasted coffee. What does that mean as far as cost? Let’s say a roaster buys coffee for $2.25 per pound. After the 18 percent shrinkage during the roast, the adjusted price of that same pound of coffee is $2.75. General operating expenses like labor, overhead, and packaging bring the final cost of a pound of coffee to around $6.50. The roaster needs to make a profit on that pound of coffee when it is sold to a cafe, so the final price would be in the neighborhood of $7.50 per pound.

Cafes are the final stop on the cost-analysis chain. According to Rhinehart, “One thing that every farmer everywhere knows is a cafe typically sells coffee for $3.50 a cup, and you get about 50 cups to a pound of coffee. So theoretically, there should be $175 in a pound of coffee. They know they are only getting $2.25 per pound.” If we take a closer look, however, the actual yield on the pound of roasted coffee is not 50 cups. Cafes that follow the SCAA Golden Cup brewing standards use 3.75-4oz of coffee to brew a 64oz pot of coffee. Consumers purchasing brewed coffee in a cafe setting are typically ordering 16oz drinks. This means there are about 15-17 cups of coffee per pound once it has been brewed. If the retailer sells the 16oz brewed coffee for $1.95, the gross sales generated on a pound of coffee is around thirty dollars. While it would still appear that the cafe is making well over twenty dollars in profit, there are fixed costs. Rent, labor, utilities and other general overhead must be covered before an actual profit is realized.

Now that we have a better idea of where the money is going to produce a cup of coffee, we also need to address what’s lacking in this system. The current mechanism used to determine pricing for specialty coffee is inadequate and does little to empower farmers. It does not allow farmers to price coffees based on their value instead of the price determined by the futures market. As Rhinehart notes, “The coffee market looks at coffee with a small c.” In other words, “all coffee is coffee” and the only person in this process that is truly subjected to the whims of the market is the farmer. If a roaster suddenly increases their price on wholesale coffee, the retailer has the option to raise menu prices. If a roaster is told by their importer to expect a cost increase, the roaster has the option to raise prices for their wholesale customers. If the cost of production suddenly goes up for a coffee farmer, they have few to no options, because the selling price for coffee is determined by an average market price.

The other piece of the conversation that’s missing is that roasters are not buying “coffee with a small ‘c’,” and specialty consumers are not drinking it that way. The kinds of coffee used in the specialty category drinks represents 30 percent or less of the coffee in the world. While most of these coffees are reasonably priced, top-quality coffees are becoming increasingly scarce and expensive. The good news is that at least roasters, retailers, and consumers are in agreement that not all coffee is coffee.

Calculating the true cost of a cup of coffee involves navigating a complex system where small profits are carved away at each transaction point. Unfortunately, average consumers don’t understand the whole value chain. Roasters and retailers are working to raise awareness though participating in programs like Fair Trade and direct trade, so when a consumer purchases their cup of coffee it reflects a fairly compensated and empowered producer.

Maria Hill is a freelance writer, blogger and founder of the social media management company Say Hey Girl. She has been involved in the coffee community in a variety of roles: SCAA staff member, event manager and coordinator, and volunteer. Maria resides in Sacramento where she can often be found enjoying her favorite snack: a warm glazed doughnut and any coffee from Ethiopia.

Buying Call Options: The Benefits & Downsides Of This Bullish Trading Strategy

Sharing is caring!

Last Updated on June 24, 2020

Buying call options is a bullish strategy using leverage and is a risk-defined alternative to buying stock. Foregoing the abstract “call options give the buyer the right but not the obligation to call away stock”, a practical illustration will be given:

  1. A trader is very bullish on a particular stock trading at $50.
  2. The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply owning stock.
  3. The trader expects the stock to move above $53.10 in the next 30 days.

Given those expectations, the trader selects the $52.50 call option strike price which is trading for $0.60. For this example, the trader will buy only 1 option contract (Note: 1 contract is for 100 shares) so the total cost will be $60 ($0.60 x 100 shares/contract). The graph below of this hypothetical stock is given below:

There are numerous reasons to be bullish: the price chart shows very bullish action (stock is moving upwards); the trader might have used other indicators like MACD (see: MACD), Stochastics (see: Stochastics) or any other technical or fundamental reason for being bullish on the stock.

Options Offer Defined Risk

When a call option is purchased, the trader instantly knows the maximum amount of money they can possibly lose. The max loss is always the premium paid to own the option contract; in this example, $60. Whether the stock falls to $5 or $50 a share, the call option holder will only lose the amount they paid for the option. This is the risk-defined benefit often discussed about as a reason to trade options.

Options offer Leverage

The other benefit is leverage. When a stock price is above its breakeven point (in this example, $53.10) the option contract at expiration acts exactly like stock. To illustrate, if a 100 shares of stock moves $1, then the trader would profit $100 ($1 x $100). Likewise, above $53.10, the options breakeven point, if the stock moved $1, then the option contract would move $1, thus making $100 ($1 x $100) as well. Remember, to buy the stock, the trader would have had to put up $5,000 ($50/share x 100 shares). The trader in this example, only paid $60 for the call option.

Options require Timing

The important part about selecting an option and option strike price, is the trader’s exact expectations for the future. If the trader expects the stock to move higher, but only $1 higher, then buying the $52.50 strike price would be foolish. This is because at expiration, if the stock price is anywhere below $52.50, whether it be $20 or $52.49, the call option will expire worthless. If a trader was correct on their prediction that the stock would move higher by $1, they would still have lost.

Likewise, if the stock moved to $53 the day after the call option expired, the trader still would have lost all their premium paid for the option. Simply stated, when buying options, you need to predict the correct direction of stock movement, the size of the stock movement, and the time period the stock movement will occur; this is more complicated then stock buying, when all a person is doing is predicting the correct direction of a stock move.

Call Options Profit, Loss, Breakeven

The following is the profit/loss graph at expiration for the call option in the example given on the previous page.

Break-even

The breakeven point is quite easy to calculate for a call option:

  • Breakeven Stock Price = Call Option Strike Price + Premium Paid

To illustrate, the trader purchased the $52.50 strike price call option for $0.60. Therefore, $52.50 + $0.60 = $53.10. The trader will breakeven, excluding commissions/slippage, if the stock reaches $53.10 by expiration.

Profit

To calculate profits or losses on a call option use the following simple formula:

  • Call Option Profit/Loss = Stock Price at Expiration – Breakeven Point

For every dollar the stock price rises once the $53.10 breakeven barrier has been surpassed, there is a dollar for dollar profit for the options contract. So if the stock gains $5.00 to $55.00 by expiration, the owner of the the call option would make $1.90 per share ($55.00 stock price – $53.10 breakeven stock price). So total, the trader would have made $190 ($1.90 x 100 shares/contract).

Partial Loss

If the stock price increased by $2.75 to close at $52.75 by expiration, the option trader would lose money. For this example, the trader would have lost $0.35 per contract ($52.75 stock price – $53.10 breakeven stock price). Therefore, the hypothetical trader would have lost $35 (-$0.35 x 100 shares/contract).

To summarize, in this partial loss example, the option trader bought a call option because they thought that the stock was going to rise. The trader was right, the stock did rise by $2.75, however, the trader was not right enough. The stock needed to move higher by at least $3.10 to $53.10 to breakeven or make money.

Complete Loss

If the stock did not move higher than the strike price of the option contract by expiration, the option trader would lose their entire premium paid $0.60. Likewise, if the stock moved down, irrelavent by how much it moved downward, then the option trader would still lose the $0.60 paid for the option. In either of those two circumstances, the trader would have lost $60 (-$0.60 x 100 shares/contract).

Again, this is where the limited risk part of option buying comes in: the stock could have dropped 20 points, but the option contract owner would still only lose their premium paid, in this case $0.60.

Buying call options has many positive benefits like defined-risk and leverage, but like everything else, it has its downside, which is explored on the next page.

Downside of Buying Call Options

Take another look at the call option profit/loss graph. This time, think about how far away from the current stock price of $50, the breakeven price of $53.10 is.

Call Options need Big Moves to be Profitable

Putting percentages to the breakeven number, breakeven is a 6.2% move higher in only 30 days. That sized movement is possible, but highly unlikely in only 30 days. Plus, the stock has to move more than that 6.2% to even start to make a cent of profit, profit being the whole purpose of entering into a trade. To begin with, a comparison of buying 100 shares outright and buying 1 call option contract ($52.50 strike price) will be given:

  • 100 shares: $50 x 100 shares = $5,000
  • 1 call option: $0.60 x 100 shares/contract = $60; keeps the rest ($4,940) in savings.

If the stock moves 2% in the next 30 days, the shareholder makes $100; the call option holder loses $60:

  • Shareholder: Gains $100 or 2%
  • Option Holder: Loses $60 or 1.2% of total capital

If the stock moves 5% in the following 30 days:

  • Shareholder: Gains $250 or 5%
  • Option Holder: Loses $60 or 1.2%

If the stock moves 8% over the next 30 days, the option holder finally begins to make money:

  • Shareholder: Gains $400 or 8%
  • Option Holder: Gains $90 or 1.8%

It’s fair to say, that buying these out-of-the money (OTM) call options and hoping for a larger than 6.2% move higher in the stock is going to result in numerous times when the trader’s call options will expire worthless. However, the benefit of buying call options to preserve capital does have merit.

Capital Preservation

Substantial losses can be incredibly devastating. For an extreme example, a 50% loss means a trader has to make 100% profit on their next trade in order to breakeven. Buying call options and continuing the prior examples, a trader is only risking a small 1.2% of capital for each trade. This prevents the trader from incurring a single substantial loss, which is a real reality when stock trading. For example, a simple small loss of 5% is easier to take for an option call holder than a shareholder:

  • Shareholder: Loses $250 or 5%
  • Option Holder: Loses $60 or 1.2%

For a catastrophic 20% loss things get much worse for the stockholder:

  • Shareholder: Loses $1,000 or 20%
  • Option Holder: Loses $60 or 1.2%

In the case of the 20% loss, the option holder can strike out for over 16 months and still not lose as much as the stockholder. Moreover, the stockholder now has to make over 25% on their stock purchases to bring their capital back to their previous $5,000 level.

Moral of the story

Options are tools offering the benefits of leverage and defined risk. But like all tools, they are best used in specialized circumstances. Options have many variables. In summary, the three most important variables are:

  1. The direction the underlying stock will move.
  2. How much the stock will move.
  3. The time frame the stock will make its move.

Buying a Call Option

Dan Kenyon/Getty Images

Traders buy a call option in the commodities or futures markets if they expect the underlying futures price to move higher.

Buying a call option entitles the buyer of the option the right to purchase the underlying futures contract at the strike price any time before the contract expires. This rarely happens, and there is not much benefit to doing this, so don’t get caught up in the formal definition of buying a call option.

Most traders buy call options because they believe a commodity market is going to move higher and they want to profit from that move. You can also exit the option before it expires—during market hours, of course.

All options have a limited life. They are defined by a specific expiration date by the futures exchange where it trades. You can visit each futures exchange’s website for specific expiration dates of each commodities market.

Finding the Proper Call Options to Buy

You must first decide on your objectives and then find the best option to buy. Things to consider when buying call options include:

  • Duration of time you plan on being in the trade
  • The amount you can allocate to buying a call option
  • The length of a move you expect from the market

Most commodities and futures have a wide range of options in different expiration months and different strike prices that allow you to pick an option that meets your objectives.

Duration of Time You Plan on Being in the Call Option Trade

This will help you determine how much time you need for a call option. If you are expecting a commodity to complete its move higher within two weeks, you will want to buy a commodity with at least two weeks of time remaining on it. Typically, you don’t want to buy an option with six to nine months remaining if you only plan on being in the trade for a couple of weeks, since the options will be more expensive and you will lose some leverage.

One thing to be aware of is that the time premium of options decays more rapidly in the last 30 days.   Therefore, you could be correct in your assumptions about a trade, but the option loses too much time value and you end up with a loss. We suggest that you always buy an option with 30 more days than you expect to be in the trade.

Amount You Can Allocate to Buying a Call Option

Depending on your account size and risk tolerances, some options may be too expensive for you to buy, or they might not be the right options altogether. In the money call, options will be more expensive than out of the money options. Also, the more time remaining on the call options there is, the more they will cost.

Unlike futures contracts, there is a margin when you buy most options. You have to pay the whole option premium up front. Therefore, options in volatile markets like crude oil can cost several thousand dollars. That may not be suitable for all options traders, and you don’t want to make the mistake of buying deep out of the money options just because they are in your price range. Most deep out of the money options will expire worthlessly, and they are considered long shots.

Length of a Move You Expect From the Market

To maximize your leverage and control your risk, you should have an idea of what type of move you expect from the commodity or futures market. The more conservative approach is usually to buy in the money options.

A more aggressive approach is to buy multiple contracts of out of the money options. Your returns will increase with multiple contracts of out-of-the-money options if the market makes a large move higher. It is also riskier as you have a greater chance of losing the entire option premium if the market doesn’t move.

Call Options vs. a Futures Contract

Your losses on buying a call option are limited to the premium you paid for the option plus commissions and any fees. With a futures contract, you have virtually unlimited loss potential.

Call options also do not move as quickly as futures contracts unless they are deep in the money. This allows a commodity trader to ride out many of the ups and downs in the markets that might force a trader to close a futures contract in order to limit risk.

One of the major drawbacks to buying options is the fact that options lose time value every day. Options are a wasting asset. You not only have to be correct regarding the direction of the market but also on the timing of the move.

Break Even Point on Buying Call Options

Strike Price + Option Premium Paid

This formula is used at option expiration considering there is no time value left on the call options. You can obviously sell the options anytime before expiration and there will be time premium remaining unless the options are deep in the money or far out of the money. 

A Stop-Loss Instrument

A call option can also serve as a limited-risk stop-loss instrument for a short position. In volatile markets, it is advisable for traders and investors to use stops against risk positions. A stop is a function of risk-reward, and as the most successful market participants know, you should never risk more than you are looking to make on any investment.

The problem with stops is that sometimes the market can trade to a level that triggers a stop and then reverse. For those with short positions, a long call option serves as stop-loss protection, but it can give you more time than a stop that closes the position when it trades to the risk level. That is because if the option has time left if the market becomes volatile, the call option serves two purposes.

  1. First, the call option will act as price insurance, protecting the short position from additional losses above the strike price.
  2. Second, and perhaps more importantly, the call option allows the opportunity to stay short even if the price moves above the insured level or the strike price.

Markets often rise only to turn around and fall dramatically after the price triggers stop orders. As long as the option still has time until expiration, the call option will keep a market participant in a short position and allow them to survive a volatile period that eventually returns to a downtrend. A short position together with a long call is essentially the same as a long put position, which has limited risk.

Call options are instruments that can be employed to position directly in a market to bet that the price will appreciate or to protect an existing short position from an adverse price move.

Finance English practice: Unit 34 — Futures

  • Complete the sentences below. Use the key words if necessary.
    • Commodity futures

    are agreements to sell an asset at a fixed price on a fixed date in the future. are traded on a wide range of agricultural products (including wheat, maize, soybeans, pork, beef, sugar, tea, coffee, cocoa and orange juice), industrial metals (aluminium, copper, lead, nickel and zinc), precious metals (gold, silver, platinum and palladium) and oil. These products are known as .

    Futures were invented to enable regular buyers and sellers of commodities to protect themselves against losses or to against future changes in the price. If they both agree to hedge, the seller (e.g. an orange grower) is protected from a fall in price and the buyer (e.g. an orange juiced manufacturer) is protected from a rise in price.

    Futures are contracts — contracts which are for fixed quantities (such as one ton of copper or 100 ounces of gold) and fixed time periods (normally three, six or nine months) — that are traded on a special exchange.

    Forwards are individual, contracts between two parties, traded — directly, between, two companies of financial institutions, rather than through an exchange. The futures price for a commodity is normally higher than its — the price that would be paid for immediate delivery. Sometimes, however, short-term demand pushes the spot price above the future price. This is called .

    Futures and forwards are also used by speculators — people who hope to profit from price changes.

    More recently, have been developed. These are standardized contracts, traded on exchanges, to buy and sell financial assets. Financial assets such as currencies, interest rates, stocks and stock market indexes — continuously vary — so financial futures are used to fix a value for a specified future date (e.g. sell euros for dollars at a rate of €1 for $1.20 on June 30).

    and are contracts that specify the price at which a certain currency will be bought or sold on a specified date.

    are agreements between banks and investors and companies to issue fixed income securities (bonds, certificates of deposit, money market deposits, etc.) at a future date.

    fix a price for a stock and fix a value for an index (e.g. the Dow Jones or the FTSE) on a certain date. They are alternatives to buying the stocks or shares themselves.

    Like futures for physical commodities, financial futures can be used both to hedge and to speculate. Obviously the buyer and seller of a financial future have different opinions about what will happen to exchange rates, interest rates and stock prices. They are both taking an unlimited risk, because there could be huge changes in rates and prices during the period of the contract. Futures trading is a , because the amount of money gained by one party will be the same as the sum lost by the other.

  • British English or American English?
    • aliminium
      • British English
      • American English

    • aluminum
      • American English
      • British English

  • Match the definitions with the words below.
    • 1. the price for the immediate purchase and delivery of a commodity — . . .

      Best Binary Options Brokers 2020:
      • Binarium
        Binarium

        The Best Binary Options Broker 2020!
        Perfect Choice For Beginners!
        Free Demo Account!
        Free Trading Education!
        Get Your Sing-Up Bonus Now!

      • Binomo
        Binomo

        Only For Experienced Traders!

  • Like this post? Please share to your friends:
    Binary Options Trading For Beginners
    Leave a Reply

    ;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: