Cocoa's Plunge Gave Traders a Wild Ride!
Fundamentals
Last Thursday was a day few Cocoa traders will ever forget, as a mid-day high volume sell-off took cocoa prices down over 7% in one minute before prices recovered. It was estimated that nearly 2000 contracts traded in the one-minute sell-off, triggering stops along the way. Although the market recovered quickly after the plunge, one cannot help but wonder if this was not a signal calling for an end to the recent up-move. Fundamentally, the news looks a bit supportive for Cocoa prices, as heavy rains have affected the flowering of Cocoa trees in Nigeria, which could lead to lower production of the main crop, which producers began to harvest last month. In addition, wet weather could spark the spread of black pod disease, which if widespread could hamper Cocoa production further. The weaker U.S. Dollar has been a boon to commodity prices in general, and Cocoa is no exception. This weakness may have been the real reason for Cocoa's nearly $300 per ton rally the past couple of weeks. The most recent Commitment of Traders report shows speculators are mixed as to the direction of Cocoa prices, with large speculators net-short Cocoa futures and small speculators holding a small net-long position. The so-called "mini-plunge" in prices may have triggered some further liquidation selling by nervous smaller traders who have decided to leave the Cocoa market entirely, fearing potentially heightened volatility if large orders enter the market.
Trading Ideas
Technical traders will notice strong resistance in December Cocoa near the 2900 area. Those looking for this resistance point to hold in the near-term may wish to explore selling calls in Cocoa options with a strike price above resistance. For example, with December Cocoa trading at 2776 as of this writing, the December Cocoa 3000 calls could be sold for about 30 points, or $300 per option, not including commissions. The premium received would be the maximum potential profit on the trade and would be realized at option expiration in November should December Cocoa futures be trading below 3000. Given the risks involved in selling naked options, traders should have an exit strategy in place should the position move against them. An example of such as strategy would to buy back the short option before expiration should the option premium trade at 3 times the initial premium received when the option was sold originally.
Technicals
Looking at the daily chart for December Cocoa, we notice the recent rally from the lows near 2600 was stopped in its tracks during Thursday's sudden plunge. Prices are having difficulty moving back into the lower boundaries of the three-month long consolidation pattern we have seen this past summer. The market is still holding above the 20-day moving average, and a close below this short-term momentum indication could spur further selling and set-up a potential test of the September lows. The 14-day RSI has turned neutral, with a current reading of 48.20. 2900 remains strong resistance in December Cocoa, with support found at the 20-day moving average, currently near the 2750 area.
Mike Zarembski, Senior Commodity Analyst
