Wool index way of future

By LIAM DANN

The arcane world of commodity futures - with its options on pork bellies and concentrated orange juice - is foreign to most New Zealanders, but a new wool index could soon change that.

SFE Corporation, which runs the NZ Futures and Options Exchange, launches a wool index tomorrow.

New Zealand manager Greg Boland says it will be ideal for farmers who want protection against big falls in the market.

"Growers are the natural sellers of wool so they should be the natural sellers of futures contracts."

Exporters would be natural buyers, as would companies such as Feltex and Cavalier, who want to protect themselves against rising wool prices, he said.

The index will initially be confined to strong wool.

That will ensure that prices are directly comparable to each other.

Boland said the specification for the new wool index was broader than earlier attempts to establish the market in the 1980s. Those attempts failed because of the range of wool types used was narrow. Too few people traded contracts and the market was easy to manipulate, he added.

"This time we've got a lot more people in the exporter segment interested. In previous attempts they've relied on the Wool Board or the farmers to provide the market."

With the index system, the settlement is based on the cash difference between the price of contract and the physical wool price at the time of the trade.

The wool futures market will trade for just one hour a day - between 3pm and 4pm.

Live prices will be on the SFE website so people can keep track of trading, Boland said.

Within a year, SFE expects 20 to 40 futures trades a day.

Three fine wool contracts operate in Australia, for 19, 21 and 23 micron lines, with 80 to 120 trades a day.

Boland said the wool futures index could be a precursor to other futures trading contracts for commodities such as logs, beef and lamb.

Om Financial will back the futures index.

Its managing director, Colin Churchouse, said farmers should reference the new index regardless of whether they actually decided to trade on it.

"It will be a very useful tool to evaluate forward sale agreements and for making investment and production decisions."



How wool futures work for farmers

The current price on the index for 36-40 micron wool is about $4.35 a kg.

If a farmer expects to sell his wool clip in mid-October, but fears the price will fall he can lock in a price by selling an October futures contract.

That should be slightly higher than the current price - for example $4.50 a kilo.

Each futures contract is for 2500 kilos.

If the farmer expects to shear 10,000kg of wool he could sell up to four contracts, depending on how much protection against price falls he wants.

If the wool price plummets from $4.50 down to $3.70 then the farmer will make 80c on the contract.

He can then sell his wool for $3.70 per kilo on the physical market.

So on 10,000kg he gets $37,000 from his wool and a further $8000 from the futures contract.

Overall he gets $4.50 per kg.

There is a catch, of course.

While the contract can smooth out the bad times in the market it also mitigates the good.

So if prices go up to $5.00 our farmer will still be locked in and can make no more than $4.50.

Farmers should adjust the amount of wool they hedge with contracts based on their expectations of the market.

It is safest to leave some wool exposed to spot prices to take advantage of favourable market movements.