Bulls Going Cuckoo for Cocoa Futures
Today's Idea
The potential of an extension of the Cocoa export ban from the Ivory Coast has to be weighed against potentially huge supplies of Cocoa entering the market should the export ban be lifted. These conflicting events seem to spell a potential increase in price volatility until the market can ascertain the extent of Cocoa supplies that will eventually reach the market. Some traders expecting an increase in Cocoa price volatility who are unsure as to the direction of the next major price move may wish to explore trading strategies that would benefit from an increase in price volatility. One such strategy would be the purchase of a strangle in Cocoa futures options. For example, with May Cocoa trading at 3583 as of this writing, one could buy a May Cocoa 3750 call as well as the May Cocoa 3450 put for about 260 points, or $2,600 per strangle, not including commissions. The premium paid would be the maximum potential risk on the trade, which would be profitable at option expiration in early April should May Cocoa futures be trading above 4010 or below 3190. However, given that time decay will work against this position, some traders may wish to exit the trade before expiration should there be less than 10 days until expiration and the option premium has fallen to less than 50% of the original purchase amount.
Fundamentals
Political unrest in northern Africa has certainly been in the news lately, sending Crude Oil futures to 2-year highs. However, another political situation in west Central Africa has sent Cocoa prices to highs not seen in 32 years, as the Ivory Coast, which is the world's largest Cocoa producer, is in the midst of a power struggle as the incumbent President Laurent Gbagbo has refused to relinquish power after losing an election late last year. There has been an export ban in place for Cocoa out of the Ivory Coast that was to have expired this week, but traders are concerned that the ban will remain in place until a leadership change takes place. Going forward, what may be a bigger concern is what will happen to the new-crop Cocoa that is expected to be harvested in April. There is little room for storage of the soon to be harvested crop, as warehouses are already filled with current Cocoa stocks that have not been moved out due to the export ban. There are growing concerns that some of the harvest will be lost to spoilage unless the export ban is lifted soon. However, should the political climate improve in the near future, we could see a flood of Cocoa hit the market, which could finally put an end to this bull market.
Technical Notes
Looking at the daily chart for May Cocoa, we notice prices breaking out to the upside last week after having spent several trading sessions stuck in a trading range between 3200 and 3400. Notice how well prices have held above the 20-day moving average, which acted as support at the recent lows. The 14-day RSI has moved into overbought territory, with a current reading of 74.2. The most recent Commitment of Traders report shows large non-commercial traders added nearly 2000 new net-long positions for the week ending February 15th. The net-long position now stands at 27,726. Although this is a large net-long position, it is still less than half the size of the record long position seen in early 2008, and leaves plenty of room for additional buying should prices continue to move higher. The next major chart support point is seen at the February 7th low of 3199. Resistance is tougher to find, as we are trading at contract highs, but a look at the continuous daily chart shows chart support at 3845, which was the highest price recorded way back in February of 1980!
Mike Zarembski, Senior Commodity Analyst
