Over-Caffeinated?
Fundamentals
Coffee futures have pulled back from the highest levels seen since the Clinton administration due to concerns that the market may be overbought. Coffee roasters have been reluctant to buy at current market levels in light of the fact that the Brazilian bumper crop is expected to be relatively large. However, despite the large crop, many traders are concerned about the scarce availability of quality beans. The cash market in many countries is still trading at or above the current futures price. This indicates that, while the buying frenzy may have subsided, the concern over quality may continue to support prices and could prevent a fire sale. The high price of Coffee has yet to be passed to the consumer in many cases. A sharp rise in retail prices could stifle demand. It does look like the emotional buying has cooled off for the time being in the futures market, but the fundamental concerns could result in range-bound trading if the cash market remains healthy. In addition to keeping an eye on the size of the Brazilian crop, many traders' focus will likely remain on the cash market. Roasters have already shown that they are hesitant to buy at current levels. If demand continues to deteriorate, there is a possibility of a crash in cash prices that would likely spread to the futures market.
Trading Ideas
While supply and demand fundamentals remain supportive for prices, the stalling of cash prices could be seen as a cause for concern among traders. Technically, the key reversal on the daily chart has not yet seen follow-through, but the rebound in prices has hardly been inspiring. Some traders may wish to enter into a limited risk strategy, such as a bear put spread. An example of such a trade would be purchasing the October 165 puts (KCV0165P) and selling the October 155 puts (KCV0155P) for a debit of 3.25, or $1181.25. The trade risks the initial premium for a potential profit of $2531.25 if the Dec future closes below 155 at expiration.
Technicals
Turning to the chart, we see the December Coffee chart forming a key reversal on Friday and Monday. After a sharp rise in prices, the reversal signal could be seen as especially significant. There has been no follow-through to the signal yet, as prices did manage to hold above relative highs at 167.00. If prices manage to close below the 167.00 level, it could trigger a wave of profit-taking. There are probably quite a few stops below the 167.00 level, suggesting a sell-off could be swift and brutal.
Robert Kurzatkowski, Trading Specialist
