The West African Cocoa Harvest Begins This Month. Here is How to Potentially Cash In Now.
If you read our Cocoa feature or watched our podcasts from last Spring, you knew that the weather scare being trumped up by cocoa bulls was a paper tiger and that the price rally couldn't hold.
You knew this because Cocoa is very much a seasonal market and bulls were touting dry weather right ahead of the African rainy season. And the rains, they did come. And the prices, they DID come down.
The West African Cocoa Harvest Begins this Month.
But the downtrend in Cocoa prices may still have a ways to go. This month, you'll discover how to potentially turn lower prices into a high yielding option sale for your portfolio.
Cocoa Prices: Where to Focus
Like some of the other softs markets, the world balance of Cocoa comes down to production in only a few key regions of the world. If you're selling options in the Cocoa market, your focus should be on West Africa.
Because over 75% of the world's cocoa supply comes from Africa, the majority of that from 4 West African nations.
Over 75% of the world's cocoa supply comes from Africa.
Thus, if you want to know something about cocoa supplies and crop cycles, this is where you look.
The Link Between the Growing Cycle and Prices
April through September marks the "rainy" season in Africa. This is also the growing season for the "main crop" African Cocoa pods. African Cocoa also has a smaller "mid crop" harvest in March/April time period. But main crop accounts for about 80% of all African cocoa production.
What you need to know about the main crop is this: Harvest of main crop in top African producers such as the Ivory Coast and Ghana begin in October.
And what do we know about commodity harvest cycles and price tendencies? If you read The Complete Guide to Option Selling, you know this: Prices tend to fall when supplies are at their highest. And when are supplies highest? Typically at harvest time.
Now, is there a guarantee that prices will behave that way this year? No, of course not. But in the past, they typically have done so as a general rule of Economics 101.
The seasonal price chart below clearly illustrates this tendency.
Cocoa prices have historically tended to decline as harvest of the West African main crop begins.
Production Deficit? Not so Much
Last spring, the bulls were afire with talk of a 2017/18 production deficit. They cited a torrid demand pace out of Europe (the world's top cocoa grinder) and potential lower yields.
But with 2017/18 world cocoa production the second-highest on record (second ONLY to 2016/17) and demand concerns growing out of emerging market risk (see: Turkey), the ICCO now predicts no deficit for the 2017/18 crop year. In fact, they see a balanced supply/demand picture. In other words, supplies are deemed adequate to meet projected global demand.
2017/18 World Cocoa Production hit 4.645 million tons, off only 2% from last year's record production.
Meanwhile, Global Ending Stocks for cocoa reach the 3rd highest level on record. Thus, the 2018/19 cocoa crop year begins with a somewhat bearish stage already set for it.
Global cocoa ending stocks are pegged 1.757 Million Metric Tons for 2017/18, 3rd Highest in History.
Conclusion and Strategy
With the beginning of the 2018/19 Cocoa harvest in West Africa this month, prices will likely be under seasonal harvest pressure through Q4 2018. While there were early weather concerns for this crop, above average rain during July and August have the crop reportedly back to health.
With abundant supplies to start the crop year and lingering concerns over emerging market demand, prices should have a tough time staging any kind of significant price rally in the immediate future. This is the textbook scenario for a call selling strategy. It doesn't mean prices will necessarily go down. The strategy only assumes prices will not rocket substantially higher in the given time period.
There is still some decent volatility in this market dating back to the weather-led rally earlier this year. This means there is some nice call premium on the table for those that want it.
May 2019 Cocoa
Selling the 2700 Cocoa Calls
We'll be considering a variety of strategies and entry points for managed portfolios this month.
Self-directed traders can consider selling the May Cocoa 2700 calls for premiums in the $500 zone. Margin requirement is reasonable at $920 - meaning a 54% ROI if and when the options expire worthless.
And as long as prices don't go screaming up, they most certainly will expire worthless. We go Cuckoo for those kinds of odds.