Cocoa/Sugar Spread: Raise the Short Sale Level

Cocoa/Sugar Spread

The nearest-futures cocoa/sugar (x2) spread posted a new contract high of +$7,791.20 (premium cocoa) on June 15th. This was the highest weekly closing price since September 1986 as the spread made it slightly past the major double top on the weekly timeframe between the 2008 high of +$7,258.80 and the 2002 high of +$7,771.60.

Cocoa Sugar (x2) spread nearest-futures weekly

Cocoa Sugar (x2) spread nearest-futures weekly

Historically, prior instances where the value of one cocoa contract was worth more than the value of the sum of two sugar contracts have been followed by major trend reversals. The smallest decline that followed drove the cocoa/sugar (x2) spread back below -$15k (premium the sum of two sugar contracts). The declines that followed the similar 2002 and 2008 tops ran the spread to -$28,492 and -$45,915, respectively. So we know that the reversal, when it comes, should offer plenty of profit potential for the savvy short seller.

On the daily timeframe, the September-October cocoa/sugar (x2) spread has made a higher monthly high and a higher monthly low for five consecutive months. The spread has held technical support at the rising 30-day Moving Average as well. Since early February, there has only been one instance where the spread closed below the 30-day MA.

September Cocoa October Sugar (x2) spread daily

September Cocoa October Sugar (x2) spread daily

A two-day close below the 30-day MA for the first time since the start of February would signal a bearish trend change for the September-October cocoa/sugar (x2) spread. A break of a prior month’s low would alter the bullish price structure. Either one of these events is good enough for an entry signal on the short side, while the next one to occur will be viewed as the confirmation.

Trade Strategy:

Cancel the current hypothetical order in the September-October cocoa/sugar (x2) spread and replace it with a new order to sell one 10-ton September cocoa contract and simultaneously buy two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 30-day MA (currently around +$4,362) or a one-day close below the June low at +$2,378 (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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