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Coffee Futures Options Trade Entry 9: Is the Bull Back?

October 30th, 2008 · No Comments

Alright, today was an interesting day. Coffee is beginning to act like itself again. Whether it will persist is yet to be determined. What was auspicious in today’s move?

Both the MACD Histogram and the Relative Strength Index gave bullish divergence buy signals today. Both have, on the whole, been very accurate over the last several years in indicating long term tops and bottoms. Both of these also flashed bullish divergence in the $1.35 area and were proved false by plummeting prices. Why should I trust them now you might ask? What is different today than a month and a half ago?

For starters, no one is in this market. Volume has been incredibly thin recently, a result no doubt of low open interest (the number of open contracts in the market). In order to have persistent selling, you typically need a large number of bulls who have yet to give up hope in a surge of selling. I argue that we’ve seen that capitulation already. If not in terms of extreme volatility, than in terms of both camps fleeing positions, meaning bulls have given up hope and bears are unwilling to add to short positions, seeing the danger in low prices and having made their profits.

This, in my opinion is very bullish. This market is exhausted, frustrated, and nervous. And in spite of it, Commercials have taken a strong stance on the long side. Again, not to sound like a broken record, Commercials have successfully picked and/or created every long term bottom in this market for the last 8 years, evidenced by their net long position at those times. And again I ask, who, if anyone, ought to know the long term relative value of a commodity if not those who actually need to deal in the physical product? Those in the know are telling us loud and clear that coffee is cheap.

The later into the season we get, the more pressure there is on this market to anticipate coming shortfalls. October through May is typically a very bullish time period, as the Brazilian harvest finished and the Vietnam harvest is currently underway. The peak of supply typically coincides with price bottoms in October through December. And while we should have learned our lesson already about picking bottoms, I still try to apply the principle of buying low and selling high (as determined by commercial positions and technical indicators).

The end of last week and the start of this one I’ve managed to add two spreads to my account:

1. Sold 1 $1.20 call and bought 2 $1.40 calls
2. Sold 1 $1.30 call and bought 3 $1.40 calls

I’m going to try to add one more spread to this ratio, giving me a net long position of 4 or 5 contracts which will begin to show a profit in the $1.40 to $1.50 price range and up. As I mentioned before, I’ll use rallies to liquidate my worthless Dec. $1.30 calls of which I still have 4, and perhaps a few of my May $1.70 calls, which are not serving much of a purpose at these prices. On price declines I’ll attempt to buy back my short call positions, thereby increasing my ratio of long calls to short, and consequently my leverage and earning potential.

Tags: Commodities · Current Trades

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