Oh, eight to 12 rand, I would say, for a decent hedge. Right, and this is where a lot of farmers immediately listen to something like that and say, amount, right? But it's not just farmers, it's roasters who can use these tools as well in similar kinds of ways to be able to manage the risk on behalf of themselves and their producing partners. So that's sharing the risk, right?
That is correct, yep. Yes, roasters can do the exact same thing just in the opposite fashion, but I will disclose because commodity markets are not stupid, commodity markets know, the commodities generally go, when they go higher, it's usually like a massive explosion higher, and so the option market prices for that. So call options are generally more expensive than put options. So for roasters, they can do the same thing, but if the math isn't gonna be quite as exciting, but for producers, it's a really amazing tool.
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We are talking about the coffee market in 2025 and 2026. We haven't quite got to 2026 yet, but we are headed in that direction in this conversation. In this episode, we're going to talk about how can producers take advantage of these high prices outside of the cash market. And I want to shout out here to Felipe Crochet because the question here came from him in our little group chat between Felipe and Angel and I.
We are trying to get people more informed about how farmers can use these tools. And Carly, there have been conversations that we have had where you've mentioned things like options and you've talked about the different ways that people can use the things that are available. And I would like to explore them as much as we possibly can in this episode. So people think the way that it works in the cash market is that whatever's happening on the C market is usually the way that in the cash market, the people who are either buying coffee cherries or green coffee or farmers, so that they can then process that, they will use the C market as sort of like a base price and then they'll add a differential based on if there's anything particularly special about that coffee.
And so the cash market really does use the C market as its base level for everything. But there's more ways that the C market can be used for farmers if they want to manage risk. So tell us about that. Okay, so I'm going to start by saying I talked to some farmers and other agricultural commodities and they're having kind of a tough go at things.
And so they tell me they can't afford to hedge, they're pinching pennies, they're operating in the red and they feel like if they try to hedge their coffee risk, they're digging themselves a bigger hole. And what I say to them is, I mean, I completely understand because we're dealing with a lot of unknowns. We don't know what's going to happen. We think we know, but we don't know.
And we're just trying to protect people from catastrophic events that put them out of business. That's really the main goal of hedging. I can honestly say you can lose a lot more in the commodity markets, whether cash market futures, whatever, just in general, you can lose a lot more money in commodities than you can ever save. So if your goal is to save a little bit of money, you're already, you have the wrong mindset.
And that's hard to re-program us because we're, you know, as humans, we take good deals on things, we like to pinch our pennies, but saving can be very, very expensive. If something happens, you know, that you're not expecting. And so I'll also say that hedging is an art, not a science, I say that a lot, and it's absolutely true. If you are looking for black and white mathematics that are just going to always work exactly how you expect, you're probably not going to find that anywhere commodities.
Anywhere, it's the wild west. But you can, anybody can look at the price of coffee here. And even if they expect it to go up, they can say, I'm 40 years old, I'm 30 years old, whatever, I've never seen coffee prices this high in my life. So you can, and you can also understand high prices, always cure high prices.
It's, there's never been an exception in the history of commodities. I know that's hard to believe, especially people that are really close to the fundamentals because there's floods, there's this and that. I'm going to mention cocoa really, really quickly. All of these, all of these things that coffee's experiencing was experienced by cocoa a couple of years ago.
Whether issues caused shortages, they lost planting acreage to illegal gold mines, I think it was. There was, there was some diseased plants. All of those stories have really been circulating in coffee and have allowed to coffee to get to $4. But if you look at cocoa, despite all of those stories and the expectation of those being long lasting, cocoa peaked out at 13,000 and now we're trading at 5,000.
And to be 100% honest, I think that's, that's about a 65, 60% correction. Just do it up. Yeah, it was two and a half thousand and, yeah. I believe two and a half thousand to 12,000.
And now it's back down to, what did you say five? Five and a half. It's about five last day check. I actually think it's going to 3000.
I think we wipe out all of that. Oh, really? And that's, unfortunately, that's just how commodities go. Because when prices are at, just imagine, cocoa farmers saw prices fluctuate, mostly between 2000 and 4000 a ton for, for probably their entire careers.
There was a few times we dipped into the 1000s, but suddenly we're talking about a market that's spent two or three decades from 2000 to 4000. Now we're trading five, 10, 13,000 as the peak. Farmers at the gas. Everybody that has any type of potential of growing cocoa, they do it.
And then this is exactly what you see. Consumers pull back. We saw a lot of candy companies start using artificial products instead of cocoa. I'm not saying that's a good thing.
This is how the behaviors are. So when prices get astronomical, everybody changes their behavior. Prices come back down. It's a boom and bust.
I wish it wasn't so dramatic because it ruins everybody's lives on both ends. But that's how it's always been. It's probably how it's always going to be. So we have to kind of expect eventually that's going to happen to coffee.
Use that as our guide. So with all those things in mind, even if you think coffee has the potential to go higher here in the short run, which I actually do. I think we probably see March coffee, which is I think we're somewhere around 360. I think we have a pretty good shot at retesting for, maybe even poking a little above it.
But you want to be prepared to do something about it. Let's say you're a producer and you want to start hedging. You don't want to always be all in on hedges or all out because again, we don't know what's going to happen in the future and you don't want to be in a situation where you're meeting margin call after margin call. That's going to happen eventually, especially in a wild market.
Like we saw this year, those types of things are going to happen on rare occasion. But if you look over a 20, 30 year period, that might have happened to, if you're a hedger that insane margin calls cycle might have happened to you four years out of 30. So we have to put it in perspective. So I know it's scary.
The problem with the market like what we're seeing in 2025, it scares producers from hedging. So even if they were hedging before, they've never hedged again because they've experienced this one bad year and it was no fun. And what I'm talking about is let's just imagine a producer and let's say coffee got to $3 and you said, well, $3 is great. I've really not seen these prices too many times in my life.
I'm going to go ahead and sell futures to hedge my downside risk in locking my price. Well, as futures go from three to four, they're losing a ton of money in their hedge account because although they're making it in the cash side, they have to come up with the loan money or cash from somewhere to pay that margin to cover that. So even if you look at it from both sides, they're not making or losing anything. They're just, it's all balancing out, but in their minds, they're losing because they could have sold their cash market copy for this much more and now they're probably paying interest on loans to be margin calls.
So it's an ugly cycle. So you never want to be all in on your hedge or all out unless if you're a producer, you probably don't want to hedge at all if coffee's at 90 cents, but if coffee's at $3 or above, you probably want to have a partial hedge at $4. I believe you should have a very aggressive hedge. Let me give you an example of what that might look like.
Selling a futures contract is one way to completely eliminate your price risk. You lock in your price. I don't generally think that's the best way to do it. I generally think the option market offers better opportunities.
For example, if you were somebody that wanted to hedge coffee today for the next 90 days, you could do something, this is not a recommendation. I'm just kind of letting you know how the math would work. Yep, for the next 90 days, you need a hedge. March coffee's trading at 360-ish.
You can sell a 430 call, which is 60 cents out of the money, meaning if coffee goes up another 60 cents, you're still making that cash market. Your hedge hasn't interfered whatsoever on your upside for that 60 cents. Above that above 430, you are basically breaking it. You're washing as the market goes up, your cash market's getting better.
Your hedge is losing money, but it's dollar for dollar roughly. It's never going to be perfect, but it's fuzzy math. It's going to roughly offset each other. I think we can all agree.
If you cap your probability at 430, that's probably not a bad deal, right? So where the real protection comes in is, though we sold that for $4.30 call. We're buying a 330 put. So it does give you risk from 360 to 330, but below 330, you have an insurance policy that protects you dollar for dollar on the downside.
So you kind of have free insurance. You're using the markets money to buy your insurance at 330. The opportunity cost is giving up gains above 430, but on paper, that's really super high probability, smart hedge, but in place. I'm going to interpret some of that for my people.
And I want to do that by, I'm going to explain us an arrow to you. You tell me if I'm understanding this correctly, Carly. So a farmer, let's say a farmer figures, I need to sell my coffee at $3 a pound. And they decide, so we'll explain some terminology here.
An option is where somebody can turn around and say, I want to buy the option to buy a contract or sell a contract. This is, I'm not necessarily going to actually, I want to buy the option to make the decision when the time comes at a specific price to either buy a contract or sell a contract, right? So a farmer who wants to sell their coffee in the cash market for $3 may want to cover themselves by saying, I want to make sure that I am going to be able to secure that price. So I am going to buy, I'm going to secure the option to sell coffee at $3 by buying a call option, or is that a put option?
It's a put, it's a put. So the put is to sell and the call is to buy. So they're going to go and cover themselves by buying a put option so that if their coffee sells for $2.50, they've still got the option to sell a contract for $3 in the market and cover whatever losses they've got. If they sell the coffee for $3, they never have to take the option up and they just lose whatever premium they paid for the option to have that as a safety net.
Have I invested that correctly? Yes, you did a very, very great job. And I apologize, I should have defined call and put it before I went into the table. So let me just back up a little bit.
So an option is an option, is technically an option to be able to buy or sell a futures contract at the strike price. So when I say sell a call, we are basically collecting a premium. In this case, the example that I gave was $4.30 call. We're collecting about three to four grand for that option.
So somebody else is buying that option. Somebody else wants the ability to buy at $4.30 because they think maybe coffee's going to $4.50, $4.60, whatever they think. We're willing to sell that to them and in exchange for the three or four grand. And we're using that three or four grand to buy a put.
That put option, I was using the $3.50 example, use the same thing though. Buying a put with a $3.50 strike price is basically saying, I want to ensure myself below $3.50 below $3.50. It's like being short of futures contracts on the way down. I'm gonna add a little thing.
Most people assume when you buy an option, you have to hold expiration. They feel like they're trapped in and it's actually the exact opposite. You can get in or out at any time frame. You can get in or out in a couple of seconds if you want to.
Yeah. Because you put this in place, it doesn't mean you have to keep it. And the great thing is, as a hedger, again, it's an art, not a science. You can kind of, I'm gonna say dollar cost average, but that's not the right term.
As the market's going up as a producer, you can establish an option hedge in increments on the way up. That way you're kind of covering your basis and you're staring up your protection instead of. So you can be creative. And if the market starts rolling down, you can peel them off incrementally and you don't have to hold expiration.
And I'll add this. If you do the strategy, I was talking about the risk reversal where you're selling a call using that money to buy your put. So you're getting free insurance financed by the market. You don't have to hold expiration.
So let's say coffee drops from 360 to, I was using 330 in the first example, I'm so sorry. Anybody? Let's say you buy the 330 put. So if coffee drops from 360 to 330, but it does so in the next couple of weeks, remember this option expires in almost 90 days.
So if it does it in the next couple of weeks, even though we're at 350 and we're, I'm sorry, 330, we're not below 330. That doesn't mean the option is not gonna be more valuable than it was when you bought it. So we probably sold our call for four grand and bought our put for four grand even money exchange. But if the market drops for us and gets down to 330, technically if we held all the way to expiration, everything would expire worthless and it's no harm, no value protected yourself, slept at night, all is good.
But we could at any time take that money off. I would, I'm just guessing because we don't know what time volatility would be. But if you did something like that and coffee dropped, we would start by buying the call back because that's where all of our exposure is. So if at some point, the coffee drops, meaning your cash market business is kind of suffering a little bit, but your futures hedge is working, we can buy that call option back at a much lower price.
And that way, if coffee turns around and starts going up, there's literally nothing impeding the upside of it. It keeps going up. We've gotten that call out of the way. So I'm just, I know this is complicated.
I'm just trying to let people know like it's, you're not stuck in forever. You can change it as the market changes. And that's really key. The worst thing you want to do is just put it on and forget it because it's like, you might as well not even have a hedge at all.
And what I mean by that is if we put this hedge on and coffee sells off the hedge benefits, we can sell our put for, even if it's only at three, futures markets at 330, our puts at 330 strike, it's not in the money, but it's worth more than what we paid for it. We can take the profit and we could maybe use the proceeds to buy a cheaper put to protect us at a lower price. I think maybe the sell-offs mostly done. So there's all kinds of customizations you could do.
I'm just gonna say one more thing. I see a lot of people that hedge that never take a profit on their hedge because they feel like they put that floor in place for a reason and they wanted to keep working for them. But at some point, let's say for example, this could be super hypothetical and kind of off the charts, but let's say you buy the 330 put and coffee just completely melts down to $2. And $2, you probably don't really need a hedge in the same way you did at 330, right?
Probably a pretty good idea to take your profit on that hedge and then let the, maybe the cash market work for you a little bit or at least reduce the cost of your hedge by buying something cheaper. So again, it's flexible, you're not stuck. And I guess for people who have never thought of using these tools before, some of the questions they're gonna have is how expensive is it to do some of this stuff? That's a good question.
So I don't know how it works in other areas of the world. In the US, producers can get bank financing loans, like operating loans. And it's, they're pretty easy to get. I don't know if it's gonna be different for other people.
But the reason being, the bank knows you own the corn or the coffee or whatever it is. So the bank knows if you're losing money in your futures account, you're making money here and vice versa. Most banks are pretty willing to finance hedges like that. So an operating loan might be the way to do it.
If you're looking at your numbers and you say, well, I just can't afford a hedge, consider doing an operating loan, hopefully not it. I mean, I'm not talking about like crazy interest rates, but if you get a reasonable one, it makes sense. And to give you an idea of the hedge that I just mentioned or one futures, or one contract is about eight grand in margin. So you'd probably want realistically, you'd probably want about 12 grand and it can help per hedge like that.
And that covers 375,000 pounds. So about eight to 12 grand, I would say for a decent hedge. Right, and this is where a lot of farmers immediately listen to something like that and say, amount, right? But it's not just farmers, it's roasters who can use these tools as well in similar kinds of ways to be able to manage the risk on behalf of themselves and their producing partners.
So they're sharing the risk, right? That is correct, yup. Yes, roasters can do the exact same thing just in the opposite fashion, but I will disclose because commodity markets are not stupid. Commodity markets know the commodities generally go, when they go higher, it's usually like a massive explosion.
And so the option market prices for that. So call options are generally more expensive than put options. So for roasters, they can do the same thing, but if the math is gonna be quite as exciting, but for producers, it's a really amazing tool. Right, and so when, let's say a producer comes to you and says, I heard you on Lay's podcast.
I don't know what the fuck you guys are talking about, but I need help. Is that something that you can walk them through? It is, yeah, and we can walk them through it. We try to give everyone, obviously, we want everyone to fully understand what they're doing.
If the consequences are before, they actually do it with real money. But the reality is, like, you could read my books. I can walk you through half links. Yeah, until you actually have it on and experience what we're talking about, it sometimes doesn't sink in.
So I would kind of encourage people, obviously, learn and understand and make sure you're comfortable with everything first, but I will also say that you're probably not gonna fully appreciate the nuances until you actually participate in it. So just be aware, and the unfortunate thing about coffee is unlike other markets where there's many micro contracts and kind of easier ways to practice hedging or hedging in a very, very small way. Unfortunately, coffee is like an all or nothing type of scenario. So it's a little different animal, but I do think it's worthwhile.
And I'll also say, again, I talk to producers of all types of commodities and it's always the exact same cycle. They get very complacent when prices are very favorable to them and nobody wants to hedge when everything's going their way. But I remind everybody, remember what it felt like for that five years from 2016 to 2019, whatever that was, maybe 14 years, first one or five years were 97. Yeah, and it wouldn't budge.
Just put yourself back in there in that mindset. Remember what that felt like, and you don't want to feel like that again. So, well, you can bet your bottom dollar, everybody that can plant coffee is planting coffee, extra as much coffee as they can, they're planting that right now. So, okay, in the next episode, folks, we're going to talk about speculators and the role that they're playing in the market and whether we need them or not.
And this is something that everybody keeps talking about is like, why do we allow speculators to be playing in coffee? So join us for the fourth episode of this series. Peace, I've been peanut butter. Take, have an amazing rest of your day.
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