April 28, 2014
Stay Short Cocoa
Keep the money on the table
In the end, aside from my firm belief all of the zigs and zags in the markets are based more on mob psychology than anything else, one of my other beliefs is: It’s all about the numbers.
I first recommended owning short positions in Cocoa on January 15th. About a week after that recommendation, Cocoa jumped about 300 points and has basically sitting there ever since.
My original, and still standing, recommendation was based on three primary factors---
ONE - Commercial Traders were holding RECORD SHORT POSITIONS in Cocoa while Speculative Traders were dead opposite them, holding RECORD LONG POSITIONS. Three and a half months later, this is still the case.
For months I have seen nothing in the media but “fundamentals are bullish” regarding this market and this DEFINITELY appears to be the majority opinion among speculators…Commercial interests, however, just as definitely seem to think there is risk on the downside. While there is no guarantee whatsoever the commercials will “win”, I have seen this situation too many times to ignore the numbers and fully expect to see the Commercials (who actually handle the commodity) take this market sharply lower…and all those speculative funds with it.
TWO - The second “number” relates specifically to the behavior of Cocoa in previous years and I think it is worthwhile to simply reproduce the statistical research I presented back in January.
ORIGINALLY POSTED JANUARY 15, 2014
Here are 15 examples of bearish moves in Cocoa going back to 2000…
You can almost make the statement: This market gets hit for 20+% (and up) on a seemingly routine basis…and it also does it pretty damn fast…
EVERY 100 POINT MOVE IS $1000 PER FUTURES CONTRACT – Be sure to note the percent changes, the time of year, how long they hang around the highs (not very long)…and the duration of the moves.
I found relatively sharp sell offs in every year since 2000. And you can be pretty certain that every one of them probably came “out of nowhere”, that they were all blipping merrily along…then just started south…and kept going and going and going.
EVERY CONTRACT SHOWN HAD AT LEAST AN 18% SELLOFF…MOST OF THEM DID SO IN UNDER TWO MONTHS.
AND FACTOR THREE – What are the numbers and the math with options? If you do buy put options, and Cocoa does start going down, what sort of return are you shooting for? Is it worth the risk of losing all your money if the market goes the wrong way, or nowhere? Given a certain size move, what could the resulting value of an option be?
Per all those histories, that for 14 straight calendar years there has been at least one 18% selloff…AND the overloaded long speculative position…I’m going to say I AM IMMEDIATELY POSITIONING FOR AT LEAST A 18% DECLINE IN COCOA PRICES SOME TIME THIS YEAR…which would take Cocoa down to around the 2500 area, or about $4500 per contract away from current levels.
And the Math is:
September 2900 puts are 95 ticks or $950 + $61 = $1011
An 18% decline, to 2500, makes that option worth $4000.
And this is presupposing the move down only matches the smallest moves since 2000. I’m not sitting here just dreaming up numbers, but what if the move is 25%? After all, the market IS loaded with specs, and as I’ve pointed out on various occasions the last 4-5 years, with all the liquidity sloshing around the markets, 30%-40% swings in commodities have almost become the norm…NOT the exception…And a 25% decline would take Cocoa down to under 2300, where that 2900 put becomes worth $6000.
No, there’s nothing that says any of this HAS to happen…and if it doesn’t any put option you buy can become worthless…but I am willing to trust all my research, and the heavy speculative long position, and my instincts…and take this bet. And the truth is, per all those numbers, if what I am anticipating has not happened by the time September goes off the board, I will do it again. I might be dead, dead wrong but I say this IS going to happen. I see this as a waiting game. You have to keep your money on the table (especially when the market begins to weaken at all, which appears to be happening now) and stay on the trade until it works…Then the next thing you have to do is stay on it while (if) it’s working…to let it happen and not be too quick to grab a “decent” profit, as, per my numbers, it COULD turn into something much bigger than that.
Here are some option possibilities…
There are innumerable ways to put together option strategies, but here is a 2&1 that is smart and has potentially quite strong leverage. These are August options, which are based on the September contract. They have a little over two months of time in them, and if they are in-the-money at expiration, they can be exercised into futures…allowing you the possibility of staying on the position right into September.
And here is just some basic win-or-lose leverage if you want to lay it out there for a bigger percentage hit…or loss.
Do I know some sort of big break is going to happen? Absolutely not. But I do know a 400-600 point drop would not surprise me in the slightest. I don’t know any more about Cocoa trees or Cocoa beans than you do. It’s a market. I’ve watched it jack back and forth for 34 years. I think the odds favor betting on the downside. I’m there…and staying there. Give me a call if you have the cash and think the risk is worth the potential reward here. Over the next few months, I think you’ll either lose it all…or hit for at least 400%.
And if you DO have the money, are interested, but not fully convinced, I’d suggest you go back and take another look at all those moves between 2000 and the present. I think the histories speak for themselves. None of this is contrived, made up…or tailored to look attractive.
GREAT TRADE I THINK.