Traders Turning a Cold Shoulder to the Coffee Market
Fundamentals
Arabica Coffee futures prices have become range bound lately, as mixed fundamentals have failed to put bulls or bears in the driver's seat. High quality beans have been scarce so far this year, as buyers scramble to secure supplies due to less than stellar crops out of Central America this past season. However, Brazil, who is the world's leading Coffee producer, is expecting a large crop this season, with current estimates for the 2010-11 harvest of just over 55 million bags. If true, this would be an increase of over 20% from last year's totals and is likely due to the cyclical nature of Coffee production. Although it appears that Coffee supplies should rebound this season, we still have to get through the South American winter, with potential frost and freeze scares providing traders a reason to keep a "weather premium" priced into the nearby futures contracts. Short-term weather forecasts area calling for cooler weather in parts of the Coffee producing areas of Brazil next week, but so far the chances for freezing conditions looks remote. Traders are also awaiting reports out of Central America regarding the extent of the damage caused in Coffee production areas due to Tropical Storm Agatha. So far it appears that there was little severe damage to the crop, but it may be too early to know the true extent of any damage to this season's production. The Commitment of Traders report shows that both large and small speculators are growing weary of the lack of direction in Coffee prices, as both non-commercial and non-reportable traders had shed a combined 6,544 contracts off their net positions as of May 25th. So unless the South American winter weather takes a turn for the worse, some traders may turn their focus to other markets as their cup of Coffee gets cold.
Trading Ideas
Since February of this year, the September Coffee futures have been stuck in a relatively narrow 11-cent trading range. Some traders expecting prices and volatility to remain muted could choose to explore trading opportunities that would benefit from a quiet market. One such strategy would be selling a straddle in Coffee futures options. An example of this type of trade would be selling the August Coffee 135 straddle. With September Coffee trading at 135.55, the straddle could be sold for about 9.00 points, or $3375, not including commissions. The trade would be profitable at this premium should September Coffee be trading below 144.00 or above 126.00 at expiration in July. Given the potential risk involved with selling naked options, traders should have an exit strategy in place should the trade move against them. An example of such an exit strategy would be to close out the trade before expiration should September Coffee close above the recent high of 142.75 or below the recent low of 131.55.
Technicals
Looking at the daily chart for September Coffee, we notice prices hovering near both the short-term 20-day moving average and the longer-term 100-day moving average. This scenario would seem to indicate that neither bulls nor bears currently have the upper hand. Many traders likely will begin to turn their focus to the rolling of positions out of the front month July contract and into September as July's June 22nd first notice day approaches. The 14-day RSI is about as neutral as can be with a current reading of 49.57. Resistance for September Coffee is seen at the April 5th high of 142.75, with support found at the February 25th low of 131.55.
Mike Zarembski Senior Commodity Analyst
