Delayed Hedge Causes Sugar To Lose 5% In Reais Over The Week.

The sugar market closed the week in fall again. May 2015, which usually reflects the sugarcane harvest from the Center-South, said goodbye to this week quoted at 12.13 cents per pound, a 55-point downturn equivalent to 12 dollars per ton. There was also a sharp 5%-fall in reals per ton against last week. And go figure! The funds are short by no fewer than 115,000 contracts.

The pace of Brazilian exports is slower. Over the first two months in 2015 sugar exports came to 3.4 million tons, a 13.5%-fall compared to the same period last year. In the twelve-month accumulated figure, exports have reached 23.6 million tons, shrinking 12.7% in relation to the same previous period. This accumulated volume has been the lowest since October 2012. The total value of sugar exports in the twelve-month accumulated amounts to US$9.12 billion, an over 20%-fall and the lowest export value collected since May 2010. Some great information for the bears – even if exports in March reach 1,475,000 tons, according to a trader’s estimate, the accumulated value over twelve months remains unchanged since March exports last year were at 1.56 million tons.

Ethanol exports over the first two months were a little over 220 million liters, falling 13% against January and February last year. In the accumulated value for twelve months the exported total is 1.36 billion liters with a 48%-melting in relation to the previous period.

In our first weekly comment in 2015, when the market was trading at about 15 cents per pound, we said, “Imagine you have US$1 million which must be bet on a digital option, that is, you must bet the market will either reach 12 cents per pound or 18 cents per pound. Where would you place your bet? Send in your opinion. Two thirds of the responses pointed to 12 cents, which are only 10 points away from getting hold of the US$1 million fictitious prize. It’s not easy to be a sugar trader nowadays.

Readers have been asking me about some of the most common over-the-counter operations, especially those called accumulators. Accumulators are contracts in which one of the parties is required to buy from the other party a certain number of sugar futures contracts in NY at a pre-determined price over a series of pre-determined dates over a specific period of time. If the closing price of the sugar at a certain date is above or below the knock-out level set between the parties, all the remaining accumulations over the specific period are cancelled.

The notional value of the contract can increase periodically, thus increasing the leverage (and the risk) if a pre-defined condition is triggered. For example, if the sugar price is above or below a certain level agreed between the parties. An accumulator is different from an exchange-traded option contract. Since they are options which depend on the price trajectory (so called path dependent options), both their pricing and Greeks calculation (sensitivity factors) are a whole lot harder to manage.

I always used the over-the-counter markets when I was a trader, especially because of the need for company hedging which went beyond what the futures market could offer in terms of liquidity back then. I can’t, therefore, be against the accumulators and I understand that the over-the-counter operations under some circumstances are much better than the exchange-traded options (mainly for industrial consumer companies) depending on the risk and commercial profile of the company and its trading traits.

What I have seen, however, is the combination of some risk factors which can cause problems for those buying and selling these instruments. For starters, in order to trade over-the-counter options, the trader, risk manager, controller, to mention a few, have to understand the scope of the risks taken (see cases which happened in the recent past to companies on the soy and even sugar market); secondly, it is not safe to use all their price fixing using accumulators. I have recently seen the case of a company which, under a price scenario simulation, sometimes would have only 50% of its volume priced (if the market fell) and sometimes 200% (if the market went up). It is clear that the managers lacked some good judgment when they let all the pricing be made by using this instrument.

Curiously, the accumulators are also known on the stock market as the suggestive name “I-Will-Kill–You-Later”. For obvious reasons, nobody has mentioned this name for the commodities market.

Today there is a variety of over-the-counter products which combines safety with risk appetite. It is always worth remembering the maxim, “One shouldn’t put all the eggs into the same basket.” As Peter Bernstein, author of the amusing book “Against the Gods” would say, “A derivative is like a razor blade. It is used for shaving, but it can kill too.”

Have a great week.