Cocoa/Sugar Spread: New Multi-Decade Highs Sends the Short Sale Campaign To the Sidelines…For Now

New Contract Highs Means “Don’t Be Short!”

Hypothetically, the IMC blog entered a short position in the December-October cocoa/sugar (x2) spread at +$6,435.20 (premium cocoa) on September 4th. Dues to the breakout to new highs, the position was exited at +$8,626.80 (premium cocoa) on September 21st. Non including commissions, this booked a loss of -$2,191.60 on the trade.

Despite the loss, the spread is still a candidate for a short sale. As a matter of fact, it is even more qualified. This is because the cocoa/sugar (x2) spread is reaching new highs that have not been seen since the 1980s and is now at a level that has only been surpassed twice in half a century. This morning’s ratio of 2.72:1 is the highest ratio since 2002 and also a historically unsustainable level.

New Parameters

With the October sugar contract set to expire in just a couple of weeks, we are going to move out to the March spread for the next trade attempt.

March Cocoa Sugar (x2) spread daily

March Cocoa Sugar (x2) spread daily

The September 3rd correction low sets the current low for the month. This is an important technical support level since it is the only place since January where the March cocoa/October sugar (x2) spread broke below a prior month’s low. It was also the only time since early February where the spread has made a close below the rising 50-day Moving Average. If it’s breached, the spread will immediately be on the defensive. Therefore, a break of the current September low or a two-day close below the 50-day MA for the first time since Q1 would be a logical technical signal to get repositioned on the short side.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 10-ton March cocoa contract and simultaneously buying two 112,000 lb. March sugar contracts if the spread close below the September 3rd reaction low of +$3,590 (premium cocoa) or makes a two-day close below the 50-day MA (currently around +$4,495), whichever occurs first. Initially, the new position will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.

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