Considerations for Trading Coffee Futures

Guatemalan Coffee Beans
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Coffee is one of the most interesting commodities to trade. It is also usually one of the most volatile. Coffee is a member of the soft complex and most of these commodities are prone to wild swings in price.

There are two main types of coffee: Robusta and Arabica. The coffee traded on the ICE Futures contract in the U.S. is Arabica. The Robusta coffee beans are considered to have more bitterness and it also contains more caffeine.

The Arabica bean is considered a higher quality bean and is used at Starbucks and for premium coffees.

For the matter of trading coffee, we will concentrate on the Arabica beans. The fundamentals of Robusta can affect Arabica prices because Robusta is a very close substitute.

Arabica beans are predominately grown in Brazil, while Columbia is the second largest producer. They are also grown in Central America, but most coffee traders focus on Brazil when they are trading coffee.

Coffee grows on small trees, so the crops are in the ground all year. This makes them susceptible to the elements of weather. The trees have to flower during the spring to produce a good crop. It is important to have good weather during this period.

Weather plays a big role in coffee production. Prolonged periods of excessive moisture or dry weather need to be watched. These events can affect yield numbers. However, the biggest threat to coffee production is frost or a freeze.

Remember, their growing seasons are the opposite of the U.S. since they are in the southern hemisphere.

Most of the biggest moves in coffee prices happen because the trees are damaged from cold weather. Be very careful trading coffee futures if the weather forecasts are calling for extreme cold weather.

Coffee can move very quickly and higher than many expect if a freeze hits the growing region of Brazil.

The demand side also plays a large role in the price of coffee. Europe is the largest consumer of coffee. They drink more per capita in Europe than the rest of the world. The U.S. is also a large consumer. Developing countries like China and South American countries are becoming more accustomed to coffee and may account for a large increase in demand in the coming decades.

Demand typically increases at a fairly reliable level. People drink coffee in good times and bad. However, if an economy falls into a deep recession, demand for coffee and basically all commodities will likely decline.

Coffee Trading Tips

Coffee futures can make wide swings within each trading day. The extreme price variance makes coffee dangerous to trade on a short-term basis unless you can devote the time to monitoring the markets throughout the day. You also have to be disciplined, control your risk and get out of the market quickly if the trade doesn’t work. Taking profits at your objectives is critical, as the market price can turn very quickly.

I prefer trading coffee from a longer-term horizon. This means looking for bigger moves in coffee over a matter of weeks, as opposed to trying to day trade the coffee futures market.

Sometimes, I will take quick profits if the market makes a windfall move. However, it makes sense to look for larger moves that have a profit ratio of three to one or risking one dollar to make three.

One of the best ways I have found to trade coffee is to sell options instead of using futures contracts. Coffee options typically have a large amount of premium in them because of the market's penchant for wide price swings. Options can work well in this market because they give you some cushion to withstand the volatility. For example, you can sell a put option instead of purchasing a futures contract. It is important to realize that selling options also carries risk similar to a futures contract. For those that do not trade in the futures market, the JO ETN product has a high degree of correlation with the price action in the coffee futures market.

 

There are many opportunities to trade coffee, but you have to be careful and disciplined. This means doing your research and have a trading plan. It also means cutting losses quickly. I would recommend following the market for a period of time, instead of jumping in on day one. The ETN product could be ideal for longer term trading positions as it carries less risk than futures or options. While the ETN can be volatile, it does not have the same degree of leverage as futures and futures options contracts.