Kenya, the world’s biggest exporter of black tea, is considering introducing the world’s first futures contracts for the leaves to help stabilize prices and enable growers to guarantee income from their production...
“The ability for farmers to be able to hedge out their pricing risk will be a big win,” Terrence Adembesa, head of derivatives at the bourse, said in an interview. “Another plus is the ability to provide a platform for investors who want exposure to a certain asset class that they currently don’t have.”
Firstly, who says that futures stabilise prices, they can smooth or exacerbate fluctuations in underlying prices, but long term do not affect them much.
Secondly, let's assume our farmer expects to harvest 100 units and is happy to sell them for $1 each, expected income $100. He can now, if he likes, sell his harvest forward (goes short).
If harvests are up ten percent and the price falls ten percent, he is even happier. He sells his first 100 units for the fixed $1 and the surplus ten units for $0.90. Total income $109.
If harvests are down ten percent and the price rises ten percent, he is knackered. He sells his 90 units for the fixed $1 and has to pay his counter-party the difference of $0.10 on the missing ten. Total income $90.
So what's in it for the farmer? Hasn't he just increased his upside and downside risks?
For the speculator who bought the 100 units forward, the calculation is the other way round. With the good harvest, he loses $10 and with the poor harvest he wins $10. Fair enough, he is just gambling with his own money, mainly against other speculators, but ultimately, all farmers' total gains/losses are the equal and opposite of all speculators' losses/gains.
Friday, 17 June 2016
My latest blogpost: Something else i don't understandTweet this! Posted by Mark Wadsworth at 10:44