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The Market Corner: the month in review

The Market Corner: the month in review

Have a drink on me

Filippo Lecchini

Wine futures are not quite like the futures contracts you know. The main reason why they exist is allowing customers to buy in advance at a lower price, the payment is upfront, high end wines before they are bottled. From the point of view of the producers is a way to eliminate exposure to price fluctuations, at least partially, and generate revenues in advance of the release date.

 

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A typical feature of a derivative market is being able to initiate a position on the long or the short side with no differences in capital usage and other limitations. Depending on the customers’ willingness to trade, in the short term volume and open interest can be generated regardless of the amount of commodities available in the physical market. Delivery and expiration will realign the futures and the spot price but a lot of participants have no intention, or means, to take delivery or deliver to a counterpart and can close their positions approaching the last trading day, when in the end only actors of the physical market deal with the actual commodities. Conversely in the equities market the amount of shares available for every listed company is fixed and on the day a company opens to investors, can be prior to going public, everyone is a natural buyer and only the company is a natural seller. Regardless of trading volume and transactions the number of shares, loosely speaking “the open interest”, does not fluctuate and there is no delivery or end date, aside from specific situations (bankruptcy, takeovers, etc.).

Wine futures are then a kind of hybrid product: the majority of the participants in the market actually intend to take delivery but the producers are really the only natural sellers. Price fluctuations and trading are possible but the open interest is anchored to actual expected production. So wine futures are really more like forward contracts which are not standardized and do not trade on a regulated exchange. Attempts have been made to create legitimate exchange futures contracts but liquidity and fragmentation of the market (different producers and vintages) prevented those efforts from succeeding.

The main risk revolves around the value of the wine once it’s finally delivered. Might turn out that the quality is not the same of the other vintages that spurred interest in the first place or something can go terribly wrong with the bottling process. These wines normally fetch hundreds if not thousands of dollars per bottles once they hit the open market so profits and losses can be material. Fraud can be certainly an issue as well, much like in the art world the possibility for counterfeits and illicit schemes cannot be overlooked. For the same reason only reputable retailers and dealers should be consulted when considering a purchase.

When people talk about wine futures they are mostly referring to Bordeaux, a large region in France known for temperate winters and warm summers. An ideal climate for growing grapes. The tradition and terroir made Bordeaux synonymous with fine wine, attracting the interest of connoisseurs, collectors and wine enthusiasts alike. Investing is obviously a good reason to buy as well. While profits and losses are not necessarily a result of trading or appreciation the spot value can be significantly higher than the futures value once delivery takes place: often these contracts are not exchanged after they are issued and allocated so the price jump is more likely to happen in the physical market where buyers large and small finally join the demand. Whether the purpose of the purchase is collecting, consumption or investment storage is always a critical component of creating and preserving value. Securing proper cellar space, where temperature and humidity are properly controlled, is a high priority for anyone willing to delve in this market.

Wine futures are a different, and entertaining if I may, market to explore for those interested in differentiating their investment away from traditional vehicles. Or just an opportunity to get for cheap the bottle of a lifetime.

Looking ahead

All eyes are already on the December FED Meeting where another hike could be announced. Currently the FED Funds Futures are implying about 75% chance. Despite the White House’s complaints the path the FED is on has been clear for quite some time and there are no signs that anything is going to change. Before the meeting though the US Midterm Elections are approaching quickly and with Congress in play the ramifications can be extensive. Policy is not only about the economy and the markets so a lot is at stakes but there are some pretty immediate priorities to address that concern the Government’s budget as the September 30th deadline was met with another short term deal.

 

RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.