Cocoa Spread Betting
The summer of 2010 saw cocoa prices go sharply up much to the resentment of bears. Analysts said there wasn’t anything fundamental driving the move; it was simply hedge fund manipulation. Backing that up, cocoa price fell back from a 33-year high at over $3,400 a metric ton down to about $2,600 in September 2010. But the political unrest in Ivory Coast is now again pushing the prices up. The main ICE second month futures contract reached up to a one-year peak of $3,390 a tonne just recently (this is quite a jump when you think that cocoa was trading at $2,840 just a few weeks earlier!). The former French colony is the world’s top contributor to the global chocolate supply, making up 40% of global supplies.
When you’ve got markets making new highs… they become attractive to trade.
That key chocolate ingredient factors in heavily to the Ivorian economy. Cocoa is its biggest source of revenue, with sweet bean sales valued at $45 billion annually. But the Ivory Coast’s cocoa trees have long-term problems, leaving aside the political problems that are now besieging the country. And the political problems have once again pushed cocoa price back up over $3,300. The record price of $3,826 per tonne was hit in 2011 in the midst of the civil war which disrupted supply.
Ghana and the Ivory Coast make up 60% of global cocoa production and the threat of the Ebola epidemic is likely to keep prices high in the medium term. Soft commodities like cocoa have certainly been quite exciting over the last months and spread betting in these circumstances represents a high risk, high reward way of speculating on cocoa prices.
Let’s take an example of a spread bet cocoa.
On February 02 2011, IG Index, quoted cocoa at 2186.0-2190.0, which represents the price in Sterling of London cocoa futures. The difference between the bid and offer prices is 4 pts; 2186 being the price at which you could sell and 2190 the price at which you could buy.
Let’s assume that you sell at 2186, putting up £20 for every point the quote moves. The deposit factor is 84 so you will need to put in £1680 to open this position (84 x 20).
To cover your potential downside you link a stop loss order to the position at 2254, so that the spread bet is automatically closed should the cocoa market move against you. Thus, if the price of cocoa drops to 2045, you will make £2820 (141 x 20). If the market moves against your position and your stop loss is hit, you will end up losing £1360.
This trade doesn’t take into account slippage since you would likely be slipped a few points given that cocoa prices tend to swing wildly. Naturally, the £20 represents a considerable risk as the price of cocoa is highly volatile but you can reduce this risk by lowering the stake.
Second Example: Selling London Cocoa with a Controlled risk bet.
You think that the price of London May Cocoa will go down. Cocoa is quoted in £/tonne. One point = £1 per tonne. You want to strictly limit your potential losses should May Cocoa rise in price, and so you open for a guaranteed stop spread bet.
Let’s say that you call for a May price and are quoted 2095.0/2101.0. A guaranteed stop would cost you +/-4 pts extra spread. So you would sell at 2095.0 – 4 = 2091.0. Your instructions is to ‘Sell May London Cocoa, £10/point, Controlled risk Bet, stop 2150.
Open position: 2091.0.
Closing position: 2150.0.
Difference: 20 points = 59 x £10 = £590.
This is exactly the maximum you could afford to lose – no surprises here as the bet was closed for exactly this reason.
Example of a Rolling Daily Spreadbet
The current price of New York Cocoa from spread betting provider IG Index is 2142.0 – 2151.0. If you think that cocoa is going to rise in the price, then you can take out a long bet, buying at 2151.0 for, say, £5 per point. If the price of cocoa goes up to 2322.5 – 2331.5, you might sell to collect your winnings. You can work out how much you won like this.
Your opening bet was placed at 2151.0, and it was closed at the selling price of 2322.5, which means that you gained 171.5 points. Your bet was for £5 per point, so multiplying this by the points gained gives you £157.50.
Some of the time, your bets will be placed in the wrong direction, and you will lose money. When this happens, you need to close your bet quickly before you lose too much. Say the price went down to 2105.0 – 2114.0, and you decided it had dropped far enough and closed your bet.
Now you can work out how much you lost. The bet was opened at 2151.0, as before, but this time it closed at 2105.0. The number of points against you is 2151.0-2105.0, which is 46 points. For your chosen stake, this amounts to a loss of £230.
This spread betting provider also offers London Cocoa prices, which are currently 1381.0 – 1385.0 for the same at future date. You may be interested that the spread is much smaller on the London prices, as prices for either market will tend to follow each other, and present similar opportunities.
Say this time you think the price will fall, and place a sell bet for £2.50 per point at 1381.0. Perhaps after a few weeks you see that the quote has dropped to 1193.5 – 1197.5, and decide to collect your winnings. The bet closes at the buying price of 1197.5.
Here’s how you work out what you won. The opening price was 1381.0. The bet closed at 1197.5. Therefore the number of points you gained on your short bet is 1381.0-1197.5, which works out to be 183.5 total points. Your bet was placed with a stake of £2.50 per point, so you multiply this out to find that you have won £458.75.
Once again, you must consider that sometimes bets do not go your way. This should not be a problem in making a profit overall, as long as you make sure that you keep your losses small so that your gains are much greater. In this example, say that the price went up after you placed your sell bet, and when it hit 1408.0 – 1412.0 you decide to close your bet and cut your losses.
This time your bet was placed at 1381.0, and the bet closed at 1412.0, the buying price. This means that the difference in points is 31. Your original bet was placed with a stake of £2.50 per point, so you simply have to multiply this through to find out how much you lost. 31 times £2.50 works out to a total loss of £77.50.
How to Spread Bet Cocoa
Of all the commodities that you can spread bet on, cocoa is probably one of the smallest markets. It is reportedly very difficult to predict, because there are always “events” occurring, such as disruption in Africa, which supplies the most cocoa to the world. In addition, cocoa is very susceptible to disease, and that can impact the market quickly. Cocoa is grown mainly in tropical rainforest conditions, and it is hard for the growers to react quickly to demand, as it takes five years before a tree even starts to produce beans.
As an agricultural product, you will see an annual cycle in the pricing. Most cocoa is produced from October to January, so it is at this time of year that the abundance or scarcity of the commodity for the following year is “discovered”. You will find that cocoa futures prices generally increase from June to August, in anticipation of the next harvest.
Of course, after harvesting cocoa must be processed, and the results of this are published every quarter, in the Quarterly Cocoa Grind numbers. The Netherlands and the United States are responsible for large shares of the processing, and the majority of cocoa is consumed in Europe and North America.
But in terms of short-term trading, which is the focus of spread betting, the prices are probably most affected by instability in the Côte d’Ivoire and Ghana, which together produce more than half of the world’s output. These areas are subject to labour, political, and social issues, so if you do much spread trading on cocoa you will learn to watch for news in this area.
Most African coffee goes to serve Europe, whereas coffee grown in Brazil and other countries of Latin America is consumed in the US. When spread trading, you may see both the American and European prices offered by your spread betting company, and as they are different countries and currencies the prices are dissimilar. Bad news in one region will impact to some extent the other, but obviously has a greater influence in the countries usually served. There is an additional market, with coffee grown in Indonesia being sent to Asian consumers, but you may not be able to spread bet directly on this one.
Here is a chart showing at the New York cocoa prices, which have been steadily declining in line with the fears over the euro zone debt. While cocoa is important for making chocolate, it is more of an optional commodity than some other foodstuffs.
The prices do not demonstrate much volatility, and apart from particular incidents as mentioned above, you can expect a reasonable stability in the pricing. It is not such a volatile commodity as many others, and thus is useful to spread trade without such a high risk when you are starting out.
The chart responds well to technical analysis, which you should choose to detect the sympathy of the market and decide on a bet direction. Given the small range of trading each day, you will be able to keep your stoploss close, protecting your capital.
Sudden Spikes in Demand
People tend to go through fads on commodities. Some years ago when the Ivory Coast – the main supplier of cocoa – went through a period of civil unrest we saw a lot of interest in this market. The really specialist such as live cattle and bean oil tend to remain largely the preserve of those who have had professional experience of trading these markets.
There has also been a pick-up of interest in the agricultural markets, as seen recently for example when the sugar price went berserk. A lot of clients will rotate into the markets when they see the price movement, but anyone thinking of trading them should make sure they have a fair idea what they are doing before they risk any money.
Manoj Ladwa, derivatives broker and technical analyst at ETX Capital, says that the company has seen some interest in the cocoa, coffee and sugar markets in the last few years, as well as in the precious and base metals, the latter again a consequence of Chinese demand pushing up prices. ‘Liquid markets such as these lend themselves to technical analysis, they are also extremely good for people who trade the trend,’ he says.
Commodity prices can remain relatively static for long periods but they can also make dramatic moves. The risks are compounded by many of the agricultural commodity markets operating a system of price limits, which means that traders could be locked into mounting losses for several days in a row with no opportunity to cut their positions. A contract that is ‘limit down’ cannot be sold and one that is ‘limit up’ cannot be bought. This applies both to the underlying market and the spread bets. One way round this is to use a controlled risk bet or guaranteed stop, which guarantees to close the position at the specified price regardless of market conditions.
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