Cocoa/Sugar Spread: Roll to May Contracts

The Bear Continues

The IMC blog has been on a short sale campaign in the cocoa/sugar spread for nearly seventeen months.  Thanks to the initial position and some ‘add-ons’ we picked up, the blog is short a March cocoa/sugar spread from the equivalent of +$21,866 (premium cocoa), short a second March cocoa/sugar spread from the equivalent of +$18,509.80 (premium cocoa), short a third March cocoa/sugar spread from the equivalent of +$15,300.40 (premium cocoa), and short a fourth March cocoa/sugar spread from the equivalent of +$1,550.40 (premium cocoa).

The bear market remains in full force, so we will remain short.  Currently, it will take a two-consecutive day close above the declining 100-day Moving Average to tell us that the trend has changed and prompt us to take the money and run.  That hasn’t happened since last April.

cocoa-sugar-spread-nearest-futures-daily

Cocoa Sugar spread (nearest-futures) daily

Furthermore, we are waiting to see what happens if/when the spread drops to -$4,000 (premium sugar).  Prior bear markets in the cocoa/sugar spread ended after this level was reached and set the stage for bull markets.  That means we will start thinking about trading the long side of the cocoa/sugar spread if it makes down to this area.

Trade Strategy:

On the four March cocoa/sugar spreads entered at the equivalents of +$21,866, +$18,509.80, +$15,300.40, and +$1,550.40 (premium cocoa), roll to the May spreads at the market-on-close on Friday, February 24th.  Risk all four spreads to a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.  

 

Cocoa/Sugar Spread: Adjust the Ratio

Recalibration

The IMC blog is still positioned on the right side of the bear market in the cocoa/sugar (x2) spread.  Currently, we are short a March cocoa/sugar (x2) spread from the equivalent of +$37.20 (premium cocoa) that was entered on September 30th of 2015!  We added a second ‘add-on’ position at the equivalent of -$3,319 (premium sugar) on February 18th and then we added a third ‘add-on’ position at the equivalent of -$6,528.40 (premium sugar) on April 19th.

The spread continued to decline so much that when our next setup to add more occurred, we decided to spread one cocoa contract against just one sugar contract instead of two sugar contracts this time.  So on November 21st, the blog sold a fourth ‘add-on’ position at +$1,550.40 (premium cocoa).

cocoa-sugar-spread-nearest-futures-weeklyWhat we did not do, however, was recalibrate our older spread positions to reflect the current ratio of approximately 1:1.  Given the fact that the prior bear market declines in the cocoa/sugar spread did not end until one cocoa contract had a premium of +$4,000 or more over one sugar contract, it makes sense to adjust our position to reflect the current ratio of the cocoa/sugar relationship and stay short.

Since there’s no time like the present, we want to go ahead and get that done.  We are going to make this our last act of 2016!

Trade Strategy:

On the short positions in the March cocoa/sugar (x2) spread entered at the equivalent of +$37.20 (premium cocoa), the equivalent of -$3,319 (premium sugar), and the equivalent of -$6,528.40 (premium sugar), exit one of the two sugar contracts in each spread at the market-on-close on Thursday, December 29th.  This will change the ratio for each spread to 1:1.  Risk all four spreads to a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.

 

Cocoa/Sugar Spread: Another Short Sale Setup

Riding the Bear

The IMC blog has been in a profitable trade in the cocoa/sugar (x2) spread for over a year now.  Based on adjustments for rollovers, we’re holding a short position in the March cocoa/sugar (x2) spread that was entered on September 30th at the equivalent of +$37.20 (premium cocoa), a second ‘add-on’ position that was entered on February 18th, at the equivalent of -$3,319 (premium sugar), and a third ‘add-on’ position that was entered on April 19th at the equivalent of -$6,528.40 (premium sugar).

march-cocoa-sugar-x2-spread-daily-75-day-ma

March Cocoa Sugar (x2) spread daily (75-day MA)

Over the last week and a half, the spread has bounced from trading near contract lows to closing just above resistance between the November 1st bounce high of -$21,195.60 and the declining 75-day Moving Average around -$21,336.20.  It’s do-or-die right here.

On the nearest-futures chart, the cocoa/sugar (x2) spread is sitting just below that same resistance level between the November 1st bounce high and the declining 75-day Moving Average.

cocoa-sugar-x2-spread-nearest-futures-daily-75-day-ma

Cocoa Sugar (x2) spread (nearest-futures) daily (75-day MA)

In addition, the nearest-futures spread has currently rallied as much as $4,158.80 from the recent low.  Since the bull market ended in September of 2015, the spread has made four other notable bounces of $5,076.40 off the January low, $5,679.20 off the March low, $4,041.60 off the July low, and $5,014 off the October low.  Based on this symmetry, the bounce could be close to completed.

Reading the Ratio

The ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract recently tagged 1:1 for the first time in over four years.  Prior bull markets that peaked at a ratio of 2.5:1 or higher were followed by multi-year bear markets that took the ratio below 0.8:1 each time.  Therefore, the current bounce could be nothing more than another bear market rally.  These are short sale opportunities and will remain so until the trend changes.

Due the decline in the ratio, the IMC blog will adapt by taking additional ‘add-on’ signals for a spread between one cocoa contract and one sugar contract.  This keeps it more dollar neutral.

march-cocoa-sugar-spread-daily-50-day-ma

March Cocoa Sugar spread daily (50-day MA)

Viewing the March cocoa/sugar spread, one can easily see that the downtrend remains fully intact and that bounces into the declining 50-day Moving Average have been selling opportunities.  Therefore, we have a green light to add to short positions right here.

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton March cocoa contract and simultaneously buy one 112,000 lb. March sugar contracts at +$1,550 (premium cocoa) or better.  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above +$3,000 (premium cocoa).   

 

Cocoa/Sugar Spread: Lots of Downside Still Ahead

Positioned In 2017

The IMC blog continues to ride the bear market in the cocoa/sugar (x2) spread.  The blog was holding a short position in the September-October cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$1,834.40 (premium cocoa), a second ‘add-on’ position that was entered at the equivalent of -$1,521.80 (premium sugar) on February 18th, and a third ‘add-on’ position that was entered at the equivalent of -$4,731.20 (premium sugar) on April 19th.

Due to the Last Trade Day for the September cocoa contract, we rolled both the cocoa and the sugar to the March 2017 contracts at the close of September 13th.  The March spread is trading $1,797.20 lower than the September-October spread, so we’re now short the spreads from the equivalent of +$37.20 (premium cocoa), -$3,319 (premium sugar), and -$6,528.40 (premium sugar).

Still Strapped In

In prior posts, we mentioned that our minimum downside target the cocoa/sugar (x2) spread is -$20,000 (premium sugar), basis the nearest-futures.  Well, we’re nearly there and the March 2017 spread has already hit -$19,340.40 (premium sugar).

cocoa-sugar-x2-spread-weekly

Cocoa Sugar (x2) spread weekly

So what now?

We are going to maintain our short position.  The reason is two-fold.  First of all, the trend is still down.  Over the last several months, the March 2017 cocoa/sugar (x2) spread has made three different bear market bounces that peaked just above the declining 50-day Moving Average.  The spread then rolled over and made new bear market lows just a few weeks or even days later.  So until the spread is consistently above the 50-day MA, the bear market remains firmly intact.

march-cocoa-sugar-x2-spread-daily

March Cocoa Sugar (x2) spread daily

The second reason to stay short is because of the history of the ratio between cocoa and sugar.  Historically, whenever the ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract has reached 2.5:1 or higher it has ultimately reversed and entered a multi-year bear market.  The ratio peaked at a thirteen-year high of nearly 2.7:1 one year ago this week.  Therefore, we may only be in the middle or even early stages of the current bear market.

Furthermore, prior bull markets that peaked at 2.5:1 or higher have been followed by substantial bear markets that pushed the ratio below 0.8:1 each time.  Think of it this way: whenever a cocoa contract has been worth at least two and a half times the value of a sugar contract, the bear market that followed pushed the sugar contract value to a premium of 35% or more over the cocoa contract.

cocoa-sugar-x2-ratio-weekly

Cocoa Sugar ratio weekly

Although sugar has been outperforming cocoa over the last few months, it still has yet to reach an equal value to the cocoa contract.  Therefore, history suggests that the smart macro bet is to stay positioned on the short side of the cocoa/sugar (x2) spread until in the value of a sugar contract is greater than the value of a cocoa contract.

We like smart macro bets!  Therefore, as long as the trend remains bearish, we’ll stay the course.

Cocoa/Sugar Spread: Roll From the Summer Spreads

Keep Rollin’ Along

The IMC blog has been on a bear market campaign in the cocoa/sugar (x2) spread for several months.  We are currently holding a short position in the July cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$2,565.60 (premium cocoa), a second ‘add-on’ position that was entered at -$790.60 (premium sugar) on February 18th, and a third ‘add-on’ position that was entered at -$4,000 (premium sugar) on April 19th.

The First Notice Day for the July sugar contract is this week and liquidity in cocoa is well established in the September contracts.  Therefore, we’re going to roll the position into the autumn contracts.

Cocoa Sugar (x2) spread (nearest-futures) weeklyA bounce into the declining 75-day Moving Average could offer another short sale opportunity.  The bounces in December, February, and April all ended after the spread clipped the 75-day MA, so we’ll look to take advantage of this pattern.  Also, if/ when the cocoa/sugar (x2) spread reaches our minimum downside target of to -$20,000 (premium sugar) we will tighten the exit parameters on the position.

Trade Strategy:

On the hypothetical short July cocoa/sugar (x2) spreads entered at the equivalent of +$2,565.60 (premium cocoa), -$790.60 (premium sugar), and -$4,000 (premium sugar), roll to the September cocoa and October sugar contracts at the market-on-close on Tuesday, June 28th. 

Cocoa/Sugar Spread: Rollin’ Out

Buying Time

Currently, we are holding a short position in the May cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$2,856 (premium cocoa) and a second ‘add-on’ position in the May cocoa/sugar (x2) spread that was entered at -$500 (premium sugar) on February 18th.

A third spread -which was another ‘add-on’ position – was entered in the July spread at -$4,000 (premium sugar) on April 19th.

We just passed the First Notice Day for May cocoa and the First Notice Day for May sugar is quickly approaching.  Therefore, we are going to roll the May spreads over to the July contracts.

Cocoa Sugar (x2) spread (nearest-futures) monthly

Cocoa Sugar (x2) spread (nearest-futures) monthly

Remember that previous rallies to +$4,500 (premium cocoa) or higher on the nearest-futures monthly chart were ultimately followed by major bear markets.  Each one crushed the cocoa/sugar (x2) spread down to -$20,000 (premium sugar) or lower.  Therefore, the spread still has a long, long way to go before we expect a bear market finale.  We’ll continue to add to the short position when the right setups materialize.

Trade Strategy:

On the hypothetical short May cocoa/sugar (x2) spread entered at the equivalent of +$2,856 (premium cocoa) and the ‘add-on’ position entered at -$500 (premium sugar), roll to the July contracts at the market-on-close on Friday, April 22nd. 

Cocoa/Sugar Spread: Adding More

Satisfying Our Sweet Tooth

This morning the IMC blog added a third short position in the July cocoa/sugar (x2) spread when it rallied to -$4,000 (premium sugar).  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above -$2,000 (premium sugar).

July Cocoa Sugar (x2) spread daily

July Cocoa Sugar (x2) spread daily

Over the last several months, the blog has increased the short position in the cocoa/sugar (x2) spread by three-fold.  With a minimum downside target of -$20,000, we hope to continue adding.  We’ll let you know if we see another setup.

Cocoa/Sugar Spread: Another Short Sale Setup

Riding the Bear

The IMC blog is holding a hypothetical short position in the May cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$2,856 (premium cocoa).  A second ‘add-on’ position was then entered at -$500 (premium sugar) on February 18th.

The recent price action has provided a setup to sell another cocoa/sugar (x2) spread.  This time, we are going to focus on the July spread since the May spreads will be rolled over in the next week or so.

Last September the cocoa/sugar (x2) spread was trading at a multi-year high.  It then gave up the ghost and triggered a short sale signal.  By all appearances, this was the start of a bear market.

July Cocoa Sugar (x2) spread daily

July Cocoa Sugar (x2) spread daily

The fourth quarter started with a break below the rising 100-day Moving Average for the first time in several months.  Once this technical support level was breached, it turned into a resistance level.

The 100-day MA has proven its worth so far.  After bottoming in early October, the July cocoa/sugar (x2) spread rallied for over two months.  It peaked after tagging the 100-day MA.

The spread once again posted a short-term bottom in mid-January.  A one-month rally followed and the spread once again crested after tagging the 100-day MA and backing down.

Another Short Sale Opportunity

The July cocoa/sugar (x2) spread reached a sixteen-month low in late March.  It then snapped back into mid-April.  At last week’s high, the spread was just $650 away from the 100-day MA.  Boy, this could have been a perfect setup: Get a test of the 100-day MA and then sell another spread if it backs off within a day or two.

Alas, Willy Wonka did not grant our wish!  The July cocoa/sugar (x2) spread fell nearly $1,900 on Friday as the sugar market exploded higher.

Be that as it may, this may still be a good time to sell short.  The recent break off the mid-April high does have some similarities to the nearly $2,400 four-day drop that occurred right after the mid-December high and the $2,100 one-day drop that occurred right after the mid-February high.  Therefore, the blog is willing to increase the short position right here and risk above last week’s high.  In just a couple of weeks, the 100-day MA should be near or even below the April 14th high.  This will serve as a technical reinforcement level.

Cocoa Sugar (x2) spread (nearest-futures) weekly

Cocoa Sugar (x2) spread (nearest-futures) weekly

From a reward-to-risk perspective, a short sale right here looks pretty lucrative as well.  If we short it at -$4k and risk to -$2k, the risk would be approximately $2,000.  Keep in mind that our minimum downside target for the cocoa/sugar (x2) spread is -$20,000 (premium sugar).  Therefore, we’d stand to make $16,000 on a short sale from here if the minimum target is reached.  Risking $2k to make $16k is a reward-to-risk ratio of 8:1.  Can’t beat that with a stick…or a chocolate bar.

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton July cocoa contract and simultaneously buy two 112,000 lb. July sugar contracts on a rally to -$4,000 (premium sugar).  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above -$2,000 (premium sugar).   

Cocoa/Sugar Spread: The ‘Add-On’ Criteria Was Met

Selling More Candy

On September 30th, the blog entered a hypothetical short position in the March cocoa/sugar (x2) spread at +$2,318.80 (premium cocoa). The spread was rolled to the May contracts on February 12th, so the position is now short from the equivalent of +$2,856. We’re risking to a two-consecutive day close above +$7,500 (premium cocoa).

The blog entered a second ‘add-on’ position this morning when the spread rallied to -$500 (premium sugar). This ‘add-on’ spread will initially be risked to a two-consecutive day close above +$2,000 (premium cocoa).

May Cocoa Sugar (x2) spread daily

May Cocoa Sugar (x2) spread daily

In mid-January the May cocoa/sugar (x2) spread posted a multi-month low of -$3,725.60 (premium sugar). A break below this level would keep the pattern of lower highs and lower lows intact, confirming the ongoing downtrend. If so, we will look for another setup to continue adding to the short position. With a minimum downside target of -$20,000 (premium sugar), we want to squeeze all the profits we can out of this move.

Cocoa/Sugar Spread: Rolling and Adding

Time to Roll and Time to Add

It’s almost Valentine’s Day. Time for love…and chocolate candy! Which reminds me: the First Notice Day for March cocoa is on Tuesday. So, outstanding long positions will have to be rolled before the long weekend. (The US markets are closed on Monday for President’s Day). Although we’re short the March cocoa and don’t necessarily have to roll yet, it may not be a bad idea to go ahead and do so. This keeps us in the contracts with the most liquidity.

The blog entered a hypothetical short position in the March cocoa/sugar (x2) spread at +$2,318.80 (premium cocoa) back on September 30th when the spread made a two-day close below the rising 50-day Moving Average for the first time in several months. We are simply going to scoot over to the May contracts.

The bearish trend change was triggered just a couple of weeks after the cocoa/sugar (x2) spread had reached a twenty-nine year high of +$8,559.60 (premium cocoa) on the weekly nearest-futures chart.

Even more interesting is the fact that the peak took the spread just past the double top at the 2002 and 2008 highs. This triggered a Wash & Rinse sell signal when the attempted breakout failed.

History Favors More Downside

In the past, rallies to +$4,500 (premium cocoa) or higher on the nearest-futures monthly chart lay the foundation for short sale opportunities in the cocoa/sugar (x2) spread. The trick, of course, is to identify the trend change and get in. After a couple of false starts, it appears that we were finally able to accomplish this.

Cocoa Sugar (x2) spread (nearest-futures) monthly

Cocoa Sugar (x2) spread (nearest-futures) monthly

Previous peaks at +$4,500 (premium cocoa) or higher were followed by bear market declines that took the spread back under -$20,000 (premium sugar). This level is our minimum downside target, so it still has quite a ways to go. Therefore, it makes sense to look for setups to add to the position and try to maximize the profits.

Current Price Pattern

Since October, the spread has closed below the weekly 50-bar Moving Average every single week. Prior to that, the weekly 50-bar MA had been acting as support on every pullback since April of ’09. Now that it has been broken, the weekly 50-bar MA has become technical resistance.

Cocoa Sugar (x2) spread (nearest-futures) weekly

Cocoa Sugar (x2) spread (nearest-futures) weekly

On the daily timeframe, the May cocoa/sugar (x2) spread spent most of October and November in a choppy trading range. After popping up nearly $3,000 from the October correction low and tagging the declining 75-day Moving Average in mid-December the spread rolled over and sank to new multi-month lows in the weeks that followed. This indicated that the 75-day MA is a resistance level to be monitored.

Therefore, is it any surprise that the recent bounce was stopped again by the 75-day MA on February 1st? And if that’s not enough, the rally also put it just $40 away from the Fibonacci .618 retracement of the decline from the mid-December peak.

In addition, the spread rallied about $3,600 off the January correction low. This was just a little bit bigger than the prior rally off the October correction low. Seems like it might be a good location to add to short positions.

May Cocoa Sugar (x2) spread dailyThe weekly 50-bar MA currently provides resistance at +$1,830 (premium cocoa) and the mid-December rally high is just a bit higher at +$2,006.40 (premium cocoa). This resistance area should be another fortress to stop the bulls if the spread does not roll over right around here. Therefore, placing protective buy stops above this area seems like a good strategy.

If a trader could sell the rally and risk just above the mid-December rally high, the risk would be somewhere between $2,000 and $2,500. With a minimum downside target of -$20,000 (premium sugar) the reward-to-risk on the trade is somewhere between 8-to-1 and 10-to-1.   That’s a good profile.

Trade Strategy:

On the hypothetical short March cocoa/sugar (x2) spread entered at +$2,318.80 (premium cocoa) on September 30th, roll to the May contracts at the market-on-close on Friday, February 12th. Risk to a two-consecutive day close above +$7,500 (premium cocoa).

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton May cocoa contract and simultaneously buy two 112,000 lb. May sugar contracts on a rally to -$500 (premium sugar). Initially, the ‘add-on’ spread will be liquidated on a two-consecutive day close above +$2,000 (premium cocoa).