Trading Coffee Options Contracts

Everyone who roasts, buys, sells, wholesales, pours or grinds coffee needs to have an understanding of the factors that drive the commodity price for coffee. I have posted several times on my predictions for the price of coffee by the end of the year, and the factors that will make those predictions happen. As I type, the "C" has appreciated approximately 18% since the credit downgrade of US debt, and the realization that the likelihood of another recession is increasing. European sovereign debt issues and the search for safe havens for capital have contributed to the appreciation of the commodity price for coffee. These factors were all identified in my earlier posts as game changers for the price to move down, but fear not, what goes up, goes down again. It is with this in mind that I wanted to start a series dedicated to profiting from the volatility of the coffee market, focusing on Options Trading. The reason I want to focus on Options Contracts rather than futures contracts, is that there is much less risk associated with Options, and no need to employ leverage. Options contracts are also very useful when there is a lot of volatility in the underlying commodity. Coffee has been a very volatile market for the past two years, and promises to continue for the foreseeable future. The upside of a well executed options contract is nearly unlimited, but the downside is limited to the purchase price of the Options Contract, therefore you'll never receive a margin call.

Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.

Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).

Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.

The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.

I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.

If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.

Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.

What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.

New Location Design Exercise

It's been a little while since I posted last. This is not due to any lack of interest or subject matter, but a family illness that has almost completely consumed my mental attention.
Rest assured I have a cranium filled with relevant topics that I hope will benefit anyone out there interested in starting their own coffee shop.

What I've decided to do is to let all of you in on the exact details involved in the design and build out of my company's new location. The space was chosen after many failed attempts at securing lease that met the following criteria:
1. Affordable Rent
2. Minimum 10 years term
3. Geographically removed from our existing locations so as not to cannibalize sales
4. Located in what is to referred to as "downtown" in my city
5. A corner or equivalent location of high visibility and traffic
6. Existing interior features that would be attractive to customers
7. The possibility of fully operational windows to permit an indoor/outdoor feeling
8. A reputable landlord who cares for their buildings and chooses their tenants carefully
9. Minimum 800 square feet, maximum 1500 square feet.
10. Suitable masthead to accomodate visible outdoor signage

The space we chose is directly across from the oldest continually operating outdoor market in Canada, which serves as an outdoor skating rink in the winter. The square is also home to antique markets, concerts, outdoor movie nights, buskers, water fountain, Christmas tree in Winter and city provided free cafe tables. It is one block from the waterfront, and directly behind our historic City Hall which served as Canada's first capital. The location is not a corner, but the open space across the street permits broad visibility and prominence.
In addition to these features, the interior space has 14' ceilings, exposed brick on one wall, and exposed limestone on the other. The front of the building will be re-pointed this fall, and new operational windows and doors installed that meet strict historical standards enforced in our city.

I have included a JPEG of the layout of the raw space listed as "322" on the drawing, and am encouraging readers to copy the image and sketch out their own versions of what they think the space should look like. Each attempt should include 2 washrooms, seating for at least 20, a service counter (cash and espresso bar). The dividing wall between 318 and 322 is exposed red brick, and the angled wall is exposed limestone. The front windows swing in to open.

Have fun and please respond with your designs in the comments. Don't worry about doing anything overly technical, just draw on it, scan it, and submit it. I hope some of the submissions will spark interesting debate, and will ultimately end up in the finished drawings. As we progress I will produce an equipment list, and budget that will adhere as close to possible to my 50 Grand Business Plan. Impossible you say! Well let's see.