Options require the up-front payment of a premium which may be relatively high. Premium costs can be reduced, from a producer’s perspective, if the product supplied provides insurance against average prices over a marketing season, rather than the possibility to benefit from day-to-day price movements. OTC providers can supply such “average price” options (also called Asian options).
So called “zero cost options,” also offered on the OTC market, make it possible for producers to get protection against the risk of falling prices, in return for giving up (whole or in part) the potential to benefit from price increases. This eliminates the need to worry about premium payments, and (in the case of cooperatives) the worry about being blamed for having “wasted” these premiums when prices move favourably.
OTC markets also offer other, more complex instruments which for some reason may suit a producer’s or cooperative’s conditions. These generally combine various types of options, and in order not to overpay the producer/cooperative needs to have a strong understanding of the pricing of such products.
What the OTC market for coffee does not offer, for the time being, is long-term instruments for the management of price risk (and this is different from the case of metals or energy products, where one may be able to enter into 25-year risk management transactions). In the coffee sector, transactions that provide a price risk management instrument for a period of more than two years have been extremely rare (one such rare exception is long-term coffee- price-linked debt provided in the early 1990s to traders and roasters in Guatemala), and even two years is unlikely to be available for most producers, given the credit risks involved for the OTC provider. So, logically, market-based price risk management cannot provide any protection against long-term declining prices. Indeed, the instruments are not meant for that: rather, they provide the producer, or other user, with certainty over a limited time period (e.g., a production season), which allows him to improve his planning and resource allocation and, in case prices are declining, with a longer period to adapt to the new market realities.
Access to the OTC market for risk management tools is largely restricted to large producers (plantations) and well-organized cooperatives—and even for these groups, the market has only seen the introduction of more innovative tools in the last few years; in the 1990s, only fairly simple products were on offer. There may, however, be a good business potential for those who manage to develop a “fortune at the bottom of the pyramid” approach that can reach the large masses of small producers in an effective manner. For example, why not package put options in the form of vouchers, like lottery tickets that give a payout if coffee prices fall below a certain level, and retail it in the same way that lottery tickets are now distributed, or alongside farmers’ inputs, or even as a premium that a bank may give to a coffee farmer who opens an account?
Experiences with price risk management for coffee farmers
Exporters from developing countries regularly use futures and options markets—such use has been reported for all Latin American countries (including Cuba), as well as for Burundi, China, India, Indonesia and Uganda. But coffee producers so far only rarely manage their price risks directly on local or international futures markets.21 More commonly, futures
21 It should be noted, however, that in the past, coffee-producing countries have tried to play an active role on coffee futures markets. In particular, in 1978 a group of Latin American countries came together in a group