Cocoa: Rain Should Spawn Correction

After climbing 18% in the last 60 days, cocoa prices have consolidated in recent weeks just under the $2500 level in December futures. I am operating under the influence that an interim top was established on 8/20 at $2547, or $100 above current trade. I'm expecting a challenge of the up-sloping trend line (blue line) in the coming weeks, if not days.

The two MAs in the chart below are the 40- and 50-day MAs (light blue and red line, respectively) seen $75 and $125 under current pricing. Use those pivot points and the Fibonacci levels on the chart below to help guide you on bearish trades.

The Forecast
Part of the reason for the decline is forecast for precipitation in some cocoa growing areas in West Africa; the #1 growing region for cocoa in the world. Futures have surged in recent weeks on lack of rain in these top-growing regions fueling concerns that quantity and quality of cocoa for the next harvest which begins in October. The rains if we do get them should allow some of this weather premium that has been built in to get stripped out.

The GBP Correlation
In previous analysis I’ve also pointed out the strong correlation cocoa has to the British Pound which has started to retrace in recent sessions. As of this post futures are challenging their 20-day MA, on a breach of that level I would anticipate a trade down to the 50-day MA which stands at $1.5345 in September futures.

The Trade
My favored play is shorting December futures and selling out of the money puts as a hedge. As of this post December futures are trading at $2450 down 1.25% on the day. One could sell a December $2400 collecting $800 per. You have just over two months on the trade. The current delta for this option is 40%. The idea is you have a cushion on the trade in case the market moves higher and on a trade lower you should make more on the futures leg than you lose on the options legs.

Look to unwind the entire trade on a move to $2300/$2325 in the coming weeks.