Bears on a Chocolate Buzz!
Wednesday, September 21, 2011
Although the Cocoa market does appear to be oversold, at least in the short-run, the overall trend does appear to favor the bears. Those looking to initiate a short position in Cocoa may wish to wait for a short-covering rally to explore selling out-of-the-money call options in Cocoa futures options. There appears to be good resistance in the December contract near the 2900 level, and selling calls above this resistance may be explored. Currently, with December Cocoa trading at 2726 as of this writing, the December Cocoa 3000 calls could be sold for about 20, or $200 per option. Given the risks involved in selling naked options, traders may wish to have an exit strategy in place should the trade move against them. An example of one such strategy would be to buy back the short options prior to expiration in November should December Cocoa close above resistance at 2900.
Fundamentals
The bull market in Cocoa futures evidenced earlier this year has certainly melted away, as prices are now hovering near one-year lows. Higher than expected production from the key Cocoa producing nations of the Ivory Coast and Ghana are weighing on prices at the same time that economic "austerity" programs in Europe are helping to curb demand. Though the 2011-12 Cocoa harvest is expected to fall short of the record crop we saw last season, many traders expect continued movement of old crop Cocoa supplies to move to market from this past year, which is keeping pressure on prices. The combination of large supplies and curtailed demand should move the Cocoa market into a surplus situation, with the International Cocoa Organization (ICCO) raising its estimate to a 325,000 ton surplus this coming season. In addition, when the National Confectioners Association releases its next Cocoa grindings report on October 20th, grindings are expected to have slowed. Speculators have begun to lighten-up on their net-long positions in Cocoa futures, with the most recent Commitment of Traders report showing both large and small speculators shedding just over 7,000 net long positions during the week ending September 13th. Even with this sharp liquidation, speculators still remain net-long Cocoa, and any rally attempts may draw in additional selling as stubborn Cocoa bulls finally throw in the towel. Though it does appear that the recent steep sell-off may be a bit overdone, it may be difficult for Cocoa prices to rally sharply unless the economic malaise we are in subsides.
Technical Notes
Looking at the daily chart for December Cocoa, we notice very few up days so far this month, as prices have fallen over $400 per ton since the end of August. The 14-day RSI has moved to oversold levels, with a current reading of 29.50. The sharp sell-off to start the week on Monday had the signs of a capitulation move by bulls, and we may start to see some sort of a bear-market rally the next several sessions that could bring about a test of chart resistance near the 2900 level. Support for December Cocoa is found near the 2650 level.
Mike Zarembski, Senior Commodity Analyst
