Cocoa/Sugar Spread: An Exit Signal and Some Reentry Parameters

Cocoa/Sugar Spread Exit

The blog entered a hypothetical short position in the cocoa/sugar spread back on October 3rd. We rolled over a couple of times and were last in the July contracts, so the spread position was short from the equivalent of +$12,256 (premium cocoa).

On Wednesday, May 13th the July cocoa/sugar spread closed above +$15k for the second day in a row. This triggered the exit criteria. Therefore, the position was liquidated at approximately +$16,044.80. The trade resulted in a hypothetical loss of $3,788.80 (not including commissions).

At today’s new closing high of +$16,499.20 the spread is not too far from nearest-futures 2010 top at +$16,589.60 or the 2014 top at +$17,510.40. It is still a qualified candidate for a trade on the short side.

Cocoa Sugar ratio daily

Cocoa Sugar ratio daily

Furthermore, the ratio between the value of one cocoa contract and one sugar contract hit 2.15:1 today. This is right on the doorstep of last year’s peak at 2.16:1, which was the highest ratio since the end of 2008. This confirms our opinion that the spread is pricey.

New Parameters

Since the cocoa contract is now worth more than double the value of the sugar contract, a spread trader can create a more dollar neutral spread by trading one cocoa contract against a pair of sugar contracts.

September Cocoa October Sugar (x2) spread daily

September Cocoa October Sugar (x2) spread daily

When plotting the spread between one September cocoa contract and two October sugar contracts, we can see that it closed at a new contract high of +$1,182 (premium cocoa) today. We can also see that the trend is fairly strong as the September cocoa/October sugar (x2) spread has only closed below the rising 30-day Moving Average on one occasion in the last three and a half months. Therefore, a two-day close below the 30-day MA for the first time since the start of February and a break below the current May low (where the spread last bounced off the 30-day MA) might be a good reason to take another stab at the short side.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 10-ton September cocoa contract and simultaneously buying two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 30-day MA (currently around -$1,368.43) or a one-day close below the May 8th reaction low at -$1,557.20 (premium the sum of the two sugar contracts), whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.

 

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