Holding on to a losing Cocoa spread trade

Cocoa - Hands with Cocoa Beans

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.

Technical Analysis

Cocoa has been parabolic over the past several weeks.  Last week Cocoa gained 15% and is up nearly 40% from the all-time high back in March of 2011.  

Current Holding

This move higher in front month Cocoa has resulted in a loss in the short September, December calendar spread that was opened in January. 

Commitment of Traders
Commitment of Traders data (commonly referred to as COT) is generated by Peak Trading Research using data published every week by the CFTC.  Hedge funds are price drivers in the agriculture markets.  Peak uses machine learning algorithms to provide daily fund position estimates and context around how extended long (red) or extended short (green) the funds are on the date listed.

Hedge Funds have reduced their longs in Cocoa significantly over the past several weeks and are currently at the lowest level since June of this year.  The current estimate of 53,563 contracts is well below the peak of 81,371 contracts in early February and the 8-month average of just under 70,000 contracts.  Despite the huge technical move higher, Hedge Funds are starting to unwind their long positions.

Spread Construction
Back-testing has consistently shown that holding a troubled trade to the scheduled close date has the highest probability of profit.  However, the trade must be constructed in a risk adverse way to enable holding through the occasional spikes.  Note that trading further out on the expiration calendar and shortening the gap between the front and back months is the best way to minimize risk and volatility.

For example:

  • The current open trade leverages the September and December expiration months.  This means that the trade had 8 months between the open date and front month and 3 months between the front and back months.  This trade lost ($1,130) for the week.
  • Constructing the trade with the same open date using the May and September expirations months has just 4 months between the open date and front month and 4 months between the front and back months.  This trade would have lost ($3,230).

Note that trading further out with a smaller gap greatly reduces volatility.

Bottom line: If I was holding the May, September spread, closing the trade and taking the loss would be a good choice because the risk of holding is so great.  However, holding the September, December spread makes holding a real option.

Given the technical action and the Hedge Fund positioning described earlier, I plan to stick with this trade a while longer.

Spread Chart
Spread Charts represent the difference between the front and back month contracts and are simply the front month price minus the back month price.  Spreads that are sold profit when the price gets more negative or less positive.  Spreads that are bought profit when prices get more positive or less negative.

In fact, I may add to this position if there is a clear break in the momentum.  I usually have specific entry and exit date, but in this case, I will hold my entry until the coast is clear.


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More Information

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




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.

On the date of publication, Darren Carlat had a position in: CAU24 , CAZ24 . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.