SpreadEdge Capital specializes in seasonal spread trading across a wide variety of commodity markets. A spread trade is the simultaneous purchase and sale of the same commodity with different delivery dates.  SpreadEdge publishes a weekly Newsletter that provides several seasonal spread trade opportunities every week.

Parabolic Cocoa 

For the past several weeks, I have been tracking the Cocoa market waiting for a good entry point.  In my weekly Newsletter for the week ended March 15, I posted the following chart and comment.

Clearly an entry around this time was far too risky so I have been waiting for the right opportunity.  In my April 19, Newsletter Cocoa was put on the watch list.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.  ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

Looking at seasonality screens for Cocoa, the September – December spread appeared on April 26 and then again on May 2. When I scheduled the 4/26 trade in the Newsletter (the weekend prior) I fully expected that I might pass on the trade if the market action Monday – Thursday that week remained bullish.  However, the 5 candles in the box (the 5 trading days prior to entry) suggested to me that the top was in, and the 4/26 entry was a go.
 

April 29 - May 3, the short Cocoa Sep – Dec calendar spread exploded into profitability.  I fully expected that I might be too early but was willing to take that chance given the long-term prospects were so good.  The timing was as much luck as skill.

Now What?

To answer this, I am looking back on a couple of trades that had a huge run up in a short amount of time.  Below is a Kansas Wheat and Crude Oil trade from February to May of 2022.  Recall that this was when the Russia, Ukraine conflict began, and we saw a huge run up in these markets.  As you can see, both Kansas Wheat and Crude Oil hit a peak, dropped, then reversed back higher for a short time, and then returned to levels near or below the original break out point.  What I’m looking for is the overall return from elevated levels and specifically how much of a drawdown occurred on the way down.  

The set up for Cocoa is a bit different from the KW and CL trades largely because the Cocoa spread hit its’ peak well before the front month started to break down.  
 

What is the profit target and how much drawdown (recovery) can be expected?

Spread target price: Looking back at historical data, the average gap in the spread price between the September and December contracts is a scant 0.3%.  Looking at the range last year between February and July, the range was from a high of 54 and a low of (12).  Even if you use the current September price of 7733, the spread would be just 23 using the 0.3% average.  Given the Friday close of 546, there is a bunch of decline in this trade.  As mentioned in the chart, anywhere from 0 to 200 is a realistic target for the U24-Z24 spread.

Recovery:  This is the biggest unknown… how much of a profit drawdown can be expected on the road from 546.  Using the KW and CL trades on the previous page, it can easily be in the ($1,100) – ($1,300) range or worse.

Trying to predict when this drawdown will occur is not realistic.  My current view is to hold the trade and be prepared to handle a drawdown in the range suggested.  If it gets worse than that, I will reassess at that time.

In my view there are 2 ways to profit on this trade.  1st is based on a decline in Cocoa to more normal levels.  2nd is further contraction in the spread price.  I expect to see both happen during the term of this trade.

  
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The SpreadEdge Weekly Newsletter is published every weekend and provides a broad overview of the important seasonal, technical, and fundamental indicators within the Energy, Grains, Meats, Softs, Metals and Currency markets.  In addition, spread trade recommendations and follow-up on open trades is also provided.  For a free copy of the Weekly Newsletter, please send an email to info@SpreadEdgeCapital.com

Darren Carlat

SpreadEdge Capital, LLC

(214) 636-3133

Darren@SpreadEdgeCapital.com

www.SpreadEdgeCapital.com

Disclaimer

SpreadEdge Capital, LLC is registered as a Commodity Trading Advisor with the Commodity Futures Trading Commission and is an NFA member. Past performance is not indicative of future results. Futures trading is not suitable for all investors, The risk associated with futures trading is substantial. Only risk capital should be used for these investments because you can lose more than your original investment. This is not a solicitation.