Commodities exchanges have been integral to human society for millennia. These markets emerged naturally, adapting to the economic dynamics of supply and demand.
To delve into the origins and evolution of commodities exchanges, we’ve explored several pivotal historical examples. Join us as we walk you through the early history of commodities exchanges, futures, and options.

The Book of Genesis

Let’s dive into the world of exchange markets with a fascinating story from the book of Genesis.

In Genesis 41, the Pharaoh of Egypt has a prophetic dream. Joseph interprets this dream, predicting 7 years of abundance followed by 7 years of famine.
To prepare, Joseph imposes a 20% tax on all grain production during the abundant years. When the famine hits, Egypt sells the stored grain to neighbouring countries, thriving in the process. This story essentially captures the essence of trading and commodity speculation.

Fast forward to today, and the concept remains largely the same. The coffee market, for instance, operates on similar principles. The price of coffee, known as the ‘C price’, functions as the exchange rate, determined in real-time by trades. These trades are simply people buying and selling contracts, facilitated by the exchange.

Here’s a simplified look at how it works:

1. Producers offer their coffee batches for delivery.
2. The Exchange buys these batches at listed price levels and stores them in its warehouses as ‘certified shares’.
3. Buyers can then purchase coffee from these certified shares at the exchange rate.

While the process has its challenges, it plays a crucial role in the supply chain. The exchange market ensures that:

• Farmers always have a buyer for their coffee, even during times of oversupply.
• The market consistently has coffee available for buyers.

This system helps stabilise the global coffee supply, ensuring a steady flow of goods despite fluctuations in supply and demand.

Futures & Ancient Mesopotamia

To truly grasp the C market, we need to understand its core: forward contracts, commonly known as ‘futures’.

Futures contracts are ancient, dating back over 4000 years to the era when humans first mastered copper metallurgy and invented the plow. Here’s how they work:

• Long Contracts: Agreeing to receive coffee from the exchange at a future date.
• Short Contracts: Agreeing to deliver a batch of coffee on a specified date.

For example, if a retailer buys coffee futures on their smartphone and holds them until they expire, they are legally obligated to take delivery of 37,500 pounds of green coffee from a warehouse certified by the Intercontinental Exchange (ICE).

Futures contracts add significant dynamics to commodity exchanges. Imagine this: In June, you agree to buy coffee futures for September delivery at $1.30 per pound. By August, if the price rises to $1.40 per pound, you can sell the contract itself and pocket a $0.10 per pound profit, instead of waiting to receive and resell the physical coffee. This type of trading is known as ‘futures speculation’, a practice that has been part of commodity markets since ancient times.

The origins of such contracts can be traced back to ancient Mesopotamia around 2000 BC. Written in cuneiform on clay tablets, these early contracts included all the modern features: details of the parties involved, the goods to be transferred, the delivery date, and the agreed price. The Sumerian temples, which functioned as storehouses and enforced regulations on quantity and quality, facilitated these trades.

Although different in many ways, these temples essentially served the same function as the ICE today. However, unlike the ICE, the temples did not purchase the goods; they simply facilitated the trade. In modern terms, this setup is similar to an over-the-counter (OTC) arrangement, where the counterparties engage directly, rather than through an exchange.

Olive Oil, Tulips & Options : Thales from Miletus and Dutch Flower Traders 

To fully understand the contracts traded in the coffee sector, it’s essential to grasp the concept of options. As the name implies, options offer their holder the right -but not the obligation- to purchase or sell multiple coffee futures at a set price. This flexibility can be incredibly advantageous when employed effectively.

To illustrate these principles, let’s turn our gaze to the wisdom of Thales of Miletus, an esteemed ancient Greek philosopher.

Thales of Miletus
The Original Options Trader

The earliest recorded example of options was referred to in a book written in the mid fourth century BC by Aristotle, a Greek philosopher of great influence and writer on many subjects. In this book, entitled ‘Politics‘, Aristotle included an account about another philosopher, Thales of Miletus, and how he had profited from an olive harvest.

Thales had great interest in, among other things, astronomy and mathematics and he combined his knowledge of those subjects to create what were effectively the first known options contracts. By studying the stars, Thales managed to predict that there would be a vast olive harvest in his region and set out to profit from his prediction. He recognised that there would a significant demand for olive presses and wanted to basically corner the market.

However, Thales didn’t have sufficient funds to own all the olive presses so he instead paid the owners of olive presses a sum of money each in order to secure the rights to use them at harvest time. When harvest time came around, and as Thales had predicted, it was indeed a huge harvest, Thales resold his rights to the olive presses to those who needed them and made a handsome profit.

Although the term wasn’t used at the time, Thales had effectively created the first call option with olive presses as the underlying security. He had paid out for the right, but not the obligation, to use the olive presses at a fixed price and was then able to exercise his options for a profit. This is the basic principle for how calls work today; now we have other factors such as financial instruments and commodities instead of olive presses as the underlying security.

Yet, it wasn’t until 1973, millennia later, that the first officially recognised options exchange was established in Chicago. This significant delay can be attributed to the lessons learned from the 17th-century phenomenon known as ‘tulip mania‘, which vividly demonstrated the volatility of unregulated options contracts.

Tulip Mania
The Volatility of Unregulated Options Contracts

When tulips came to the Netherlands, all the world went mad. A sailor who mistook a rare tulip bulb for an onion and ate it with his herring sandwich was charged with a felony and thrown in prison. A bulb named Semper Augustus, notable for its flame-like white and red petals, sold for more than the cost of a mansion in a fashionable Amsterdam neighborhood, complete with coach and garden. As the tulip market grew, speculation exploded, with traders offering exorbitant prices for bulbs that had yet to flower. And then, as any financial bubble will do, the tulip market imploded, sending traders of all incomes into ruin.

Tulip mania is widely regarded as the first recorded speculative economic bubble in human history. At the time, tulips were incredibly popular in Holland and were considered to be status symbols among the Dutch aristocracy. Their popularity spread into Europe and throughout the world, and this led to a demand for tulip bulbs increased at a dramatic rate.

By this point in history, calls and puts were being used in many different markets, primarily for hedging purposes. For example, tulip growers would buy puts to protect their profits just in case the price of tulip bulbs go down. Tulip wholesalers would buy calls to protect against the risk of the price of tulip bulbs going up. It’s worth noting that these contracts weren’t as developed as they are today, and options markets were relatively informal and completely unregulated.

During the 1630s, the demand for tulip bulbs continued to increase and because of this, the price also went up in value. The value of tulip bulb options contracts increased as a result, and a secondary market for these contracts emerged which enabled anyone to speculate on the market for tulip bulbs. Many individuals and families in Holland invested heavily in such contracts, often using all their money or even borrowing against assets such as their property.

The price of tulip bulbs continued to rise, but it could only continue for so long and eventually the bubble bursted in 1637. Prices had risen to the point where they were unsustainable, and the buyers started to disappear as the prices began to plummet. Many of those that had risked everything on the price of tulip bulbs continuing to rise were completely wiped out. Ordinary people had lost all their money and their homes. The Dutch economy went into a recession.

Because the options market was unregulated, there was no way to force investors to fulfill their obligations of the options contracts, and this ultimately led to options gaining a bad reputation throughout the world…

It wasn’t until 1973 that the first formally traded options exchange The Chicago Board Options Exchange – Cboe was established in Chicago largely due to the lessons learned from tulip mania. This modern framework, with enforced regulations and a central exchange, allowed options to become a reliable and popular tool for investors.

American brokers demonstrated that options could be a viable over-the-counter product, paving the way for their resurgence in the late 20th century. Today, options are widely used in markets around the world, including the coffee sector, offering traders flexibility and strategic opportunities.

The Dojima Rice Exchange : The First Centralised Futures Market 

While Mesopotamian temples displayed many of the features of modern ICE, the market was more like an OTC market, as the temples did not purchase the goods.
To find the first example of a truly modern futures exchange, we must instead look to the late 17th century Japan and the Dojima Rice Exchange.

Established in 1697 in Osaka, Japan, its primary objective was to standardise and regulate the trade of rice, a vital commodity in Japan’s economy. During this era, rice held immense significance, constituting up to 90% of government revenues.

The economic landscape of 17th-century Japan was unique, with samurai and officials receiving salaries in rice and workers paying taxes in the same commodity. This distinct setting spurred early advancements in Japan’s banking sector, allowing customers to deposit rice and withdraw cash.
Simultaneously, rice served as a staple food in Japan, creating a consistent demand for the commodity.
To mitigate the risk of price fluctuations, Japanese merchants began organising futures contracts. These agreements empowered buyers to secure rice at predetermined prices in advance, ensuring a stable and dependable supply.

Legal documentation for these agreements was centralised on the north bank of the Osaka’s Dojima river. This location, frequented by merchants and traders, eventually became known as the Dojima Rice Exchange.

The Dojima Rice Exchange boasted all the essential features of a modern futures exchange, including spot and futures markets, standardised contracts, and centralised clearinghouse operations. It also showcased the potential of futures markets to reduce price volatility, as evidenced by a decrease in rice price fluctuations following its establishment.

As the world’s first organised commodity futures exchange, the Dojima Rice Exchange paved the way for modern exchanges like the ODEX (Osaka Dojima Exchange) and the CME (Chicago Mercantile Exchange), leaving an indelible mark on global financial markets.

The C-Market 

Coffee futures have been traded in New York since 1882, initially on the New York Coffee Exchange. The Coffee Exchange of the City of New York was established to provide importers a safeguard against fluctuations in the price of Brazilian Arabica coffee. Its inception in 1882 followed the ‘coffee crash’ of 1881, where several companies unsuccessfully attempted to monopolise the coffee market.

The ICE Futures U.S. Coffee ‘C’ contract is the benchmark for world coffee prices. Its depth, liquidity, volatility, and diversifying properties make it a preferred instrument among commodity trading advisors and hedge funds. ICE Futures U.S. stands as the exclusive global market for Coffee ‘C’ futures and options.

Each futures contract represents 37,500 pounds (±17,000 kg) of exchange-grade coffee. The buying and selling of these contracts determine the global trading price of arabica coffee, known as the C-price. This C-price serves as a benchmark for participants in the coffee supply chain.

The coffee supply and demand are highly volatile due to various factors such as abnormal weather conditions and disease outbreaks affecting harvests. Consequently, the C-market experiences daily price fluctuations as it continuously adjusts to supply and demand changes.

Gaining insights into the mechanics of the C market can empower you to anticipate market shifts, mitigate risks, and optimise procurement strategies amidst market volatility.

If you’re interested in understanding the causes of C-market volatility, the factors influencing the C-price, or do you want to discuss some risk management strategies, reach out to EFICO’s green coffee traders.

Led by Michel Germanès -a seasoned expert with over forty years of experience in the coffee industry, EFICO’s trader team brings together an impressive 150 years of collective expertise. They are ready and would be happy to offer you valuable insights into the intricacies of the C-market and the C-price.

Michel Germanès, CEO EFICO Group

ICE  I  Coffee C Futures

U.S. Department of Agriculture I “Coffee: World Markets and Trade,” Page 6,9

iPath I  “iPath Series B Bloomberg Coffee Subindex Total Return SM ETN.”

Trading Economics I  Coffee Markets