Coffee prices are skyrocketing, forcing traders to seek alternative hedging strategies.

Noticed that the price of coffee has been soaring, for traders buying and transporting coffee beans worldwide, this means taking on more risks. They are seeking other ways to hedge prices, to avoid or delay cash shortages caused by price fluctuations. The futures price of Arabica coffee (the preferred variety for premium coffee) has risen by about 70% in New York this year, breaking the highest level in over 40 years. Price fluctuations are common. When prices fluctuate too high and too fast, exchanges or brokers managing trading positions may require traders to provide more collateral or margin to maintain unprofitable sold futures hedges. With millions of bags of coffee in inventory or in transit, when prices fluctuate significantly, this could mean billions of dollars in margin requirements. For traders with goods already on ships or waiting for final payment from buyers, additional margin calls could quickly deplete their cash positions. Traders and brokers say they are increasingly turning to options and over-the-counter trading solutions to avoid paying more collateral or simply reducing business volume. These measures indicate that in a market dominated by small businesses, liquidity pressure is constantly increasing, and these businesses are not prepared for large-scale cash demands. This leads to further price volatility and reduced exchange liquidity. Another popular commodity this year, cocoa, has encountered similar issues. "It's a very turbulent time, very very difficult for traders," said Kit Gulliver, director of UK coffee traders Origin Commodities Ltd. and Dragon Commodities Ltd. "You have to change the way you handle these things. Just sitting there doing what you used to do will only lead to loss of cash." When coffee is shipped from producers in countries like Brazil, Vietnam, or Guatemala to buyers in Europe and the US, traders need to hedge risks. When traders commit to purchasing physical coffee at exchange-related prices, they typically sell futures to protect or hedge against the risk of falling commodity values. An advisor from top coffee producer Brazil estimates that as much as $70 billion in margin calls were made in the coffee market in November. For some time, banks have been offering a product called "liquidity swaps" to large groups, where the bank charges a fee to hold the hedge for a period of time. This structure allows traders to avoid margin calls related to commodity delivery before it occurs, but if prices don't decrease by the end of the agreement, they may ultimately have to pay the margin. Traders say that in the recent coffee bull market, brokers and financial services groups have also been offering this product to smaller clients. "There has definitely been an increase in demand for these products," said Albert Scalla, senior vice president of trading at StoneX Group Inc., adding that the company provides limited liquidity swap services to clients. He said traders also use swaps to alleviate other forms of collateral burdens, such as the initial margin required for hedging. Repurchase agreements have also become increasingly important for the industry. In these agreements, traders sell physical coffee to a bank or broker, receive temporary cash, and avoid the pressure of price fluctuations. They then repurchase the goods at an agreed upon interest within a specified time. Drew Geraghty, soft commodities broker at TP ICAP Group Plc, said, "There is a lot of over-the-counter activity, whether it's banks doing liquidity swaps or actually buying the physicals from the trade and then selling them back to free up some cash." However, if the continuously increasing inventory in ICE warehouses is any indication, the last resort would be to reduce trading volume and the amount of coffee in transit. This is not to say that now is not a favorable time to enter the market. In the first-half financial report of Louis Dreyfus Company in September, its coffee department's performance was highlighted, partly due to an increase in original profit margins.