Coffee –A cup of Joe for your Portfolio

Drinking too much coffee can surely cause an upset stomach and having too large of a position and being on the wrong side of the market of late likely could end in the same result. In recent sessions it’s been like the Wild West with a range H/L of over 12 cents in 2 sessions last week. As one can see after the spike higher last week that lifted futures to the highest trade since 5/23 prices have settled back and appear to be finding support at the 20 day MA (light blue line).

I have been advising scaling into bullish trade for weeks now and it appears prices are finally starting to cooperate. After range bound trading for several weeks just above $120 markets awoke last week. This week is far from over but a positive week would translate into higher trade 4 out of the last 5 weeks…stay tuned.

Chart 1:

Coffee Futures, July 23, 2013
Coffee Futures chart, July23, 2013

My favored play for clients is a three legged trade. Like a bar stool I do not think it is adequate unless all three legs are utilized. Long December futures (1)… sell (1) out of the money December call collecting theta with a cushion against a retracement lower. My advice is sell a strike with a delta between 40-50% so that if we are correct and get a spike higher there is room to make on the futures as the sale of the call option will result in a loss on higher trade. The third leg is purchasing (1) September out of the money put. There is just less than three weeks time so you are not paying an immense premium and this should only serve as a safety net if we retest the lows. On a trade back near $120 I would offset this leg and go to cash on this leg.

So why a bullish trade in coffee? After a 20% decline in the last three months we are finding value in recent weeks. Futures last week traded above the 50 day MA (red line) for the first time since mid May. Potential freezes in Brazil that could cause crop damage…even if major coffee regions avoid the cold weather at a minimum it could trigger short covering as recent COT report shows a large short position with funds and spec traders. See weather map on regions of Brazil below. When you think coffee you think Brazil as they produce approximately 25% of the world’s coffee. A recovery in the Brazilian Real could also be supportive.

Just to be clear a spike if we get it to the 50% ($134) or 61.8% ($138) Fibonacci levels as seen on the chart above should be viewed as exit doors.

Chart 2:

Coffee frost forecast
Coffee frost watch in Brazil

Chart 2 provided by EGSI Consulting: EGSI is a US based multi-disciplinary consulting firm founded in 09’ on principles of scientific integrity, sustainable development, excellence in quality, and customer satisfaction, EGSI has developed an array of products and services to address the scientific research, development, production and operational requirements of their clients. Rao Achutuni established EGSI on the foundations of his 30 years of combined experience, formerly with the USDA and NOAA.

Together with RCM Mr. Achutuni is in the process of setting up a CTA that will focus solely on Agriculture and Softs trading-contact me for more details.

Risk Disclaimer: This information is not to be construed as an offer to sell or a solicitation or an offer to buy the commodities and/ or financial products herein named. The factual information of this report has been obtained from sources believed to be reliable, but is not necessarily all-inclusive and is not guaranteed to be accurate. You should fully understand the risks associated with trading futures, options and retail off-exchange foreign currency transactions (“Forex”) before making any trades. Trading futures, options, and Forex involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more than your initial investment. Opinions, market data, and recommendations are subject to change without notice. Past performance is not necessarily indicative of future results. This report contains research as defined in applicable CFTC regulations. Both RCM Asset Management and the research analyst may have positions in the financial products discussed.