Bullish Traders Developing a Sweet Tooth
Fundamentals
"Sweet"! That was the cry from Sugar bulls to start the week, as futures prices exploded to the upside and reached highs not seen since 2006, as trend-following traders continued to add to existing long positions. The lower than expected Sugar production out of India has been the main catalyst for higher prices this year, as the country is expected to be a major importer of Sugar, with some estimates as high as 1 million tons being purchased. Domestic Sugar prices in India have risen by almost 30%, despite efforts by the government to quell the price rise. The monsoon season in India has started slowly, sparking fears that Indian Sugar production may not rebound as much as earlier thought. Brazilian producers are the beneficiaries of higher world Sugar prices, and Sugar production has been well ahead of last year's totals. Even though Sugar prices are attractive to Brazilian producers, higher oil prices are also attracting a fair amount of cane production into Ethanol -- especially by more cash-strapped producers. There have been rumors floating around that a large commercial trader will stand for delivery against the July contract, which has sparked a round of short-covering buying ahead of the last trading day on June 30th. Spread trading has been very active, as traders move their positions over to the October futures. Although the Sugar bull market looks to be alive and well, many end-users outside of India have started to balk at paying the current high cash Sugar prices -- which could drastically cut demand. Also, should the U.S. Dollar begin to rebound, it could put pressure on the entire commodity complex, and markets with a large net-long speculative interest like Sugar could be especially vulnerable for a nasty sell-off as long liquidation occurs.
Trading Ideas
Even the strongest bull markets are subject to price corrections to shake out weak longs, and outright long futures positions are vulnerable to potential slippage on sell-stop orders -- especially as price moves become more volatile at higher prices. One way traders can limit the risk on entering a potentially volatile market is through the use of futures options. An example of a trade that will benefit from a large move in the underlying futures market or an increase in volatility is the purchase of strangles. In the case of Sugar futures, an example of this trade would be buying an October Sugar 18-cent call and buying an October Sugar 16.50 put. With October Sugar trading at 17.25 as of this writing, the straddle could be purchased for 1.91 points, or $2,139.20 plus commissions. The premium paid is the maximum risk on the position, and break-even occurs if October Sugar is trading above 19.91 or below 14.59 at expiration in September. However, most traders will exit the position early, especially if volatility increases sharply or the market makes a big one-direction move to help negate the effects of time decay on the long straddle position.
Technicals
Looking at the daily chart for October Sugar, we notice how violently prices surged this week after Monday's solid close, which signaled the end of the recent price correction. Prices are now well above both the 20 and 100-day moving averages, which is an encouraging sign for bullish trend-following traders. The major negative technical indicator is the bearish divergence in the 14-day RSI, which may give some traders pause from entering new long positions. 17.50 looks to be solid resistance for the October contract, with last week's lows of 16.02 acting as support.
Mike Zarembski, Senior Commodity Analyst
