Friday, August 31, 2007

My Experiences Trading Sugar Commodity Futures Contracts and Options

Sugar trading is romantic! Here's some valuable hints and kinks taken from actual trading experiences.

Sugar is a great market for beginning commodity traders. Sugar futures contracts require a small margin and rarely make extreme moves. Currently, an account margin of $1200 will control about $13,000 worth of sugar. (112,000 lbs at 12 cents per pound) A one cent move in sugar equates to $1120.

Brazil is now energy independent from its use of ethanol in the form of alcohol. Ethanol is derived from sugar. This has brought a great increase in the number of speculators and commercial hedgers trading in sugar futures and options. The volatility and liquidity generated is a positive by-product.

Sugar trades for only three hours a day, from 9am-12pm. What a great life to be an expert sugar trader! It's a fifteen hour work week.

Sugar has made several extreme moves over the last thirty-five years. The last big move to 18 cents a pound was last year. In the early 1980's sugar hit 44 cents a pound. In the early 1970's sugar hit 66 cents!

On the other side, sugar once got as low as 2.5 cents a pound. The whole 112,000 pound contract was worth only $2800! You could have taken delivery and warehoused it for a few years and sold it for 15 cents a pound or $16,800. (Or just kept rolling the contracts forward with no delivery) That's not a bad profit if you believed sugar was not going to be free. Multiply this times ten contracts and you are looking at over $160,000 on a $30,000 investment. There certainly is opportunity if one is willing to take on the risk.

During normal or quiet markets, options on sugar futures are usually cheap and you can buy a lot of time. Strategies are abundant for spreads, straddles, and strangles. Sugar makes lots of long-term patterns and formations. Wave analysis and swing trading works well for sugar when it's trending.

Some traders look for the possibility of "pyramiding" contracts when sugar is active. This is a risky technique used when the market is in an extended trend. A trader tries to keep adding futures positions using previous profits. Dont ever forget this is a double edge sword. If you add to positions, make sure to adjust catastrophic stops so that your losses are not out of control if the market reverses. If the market stops you out and moves in the other direction, dont be afraid to get back in if the trend is still intact. Sugar trends can last a lot longer then most expect.

Look to exit positions after big moves during the morning opening or near the close. Sugar futures tend to reverse after very large moves by gapping open the following day. Try not to keep big profits over the weekend thinking Monday morning will have a big follow through. You may want to lighten up on Friday right before the close.

If you feel nervous about holding onto big profits, my best advice and rule of thumb is to keep one-half of your position and sell one-half. This way you can never be more than one-half wrong, and one-half right. This is a form of "scaling out", which is a favorite technique of mine. Besides, after a climatic move the option prices are usually very inflated. The option premiums may actually decline on a flat opening Monday because the previous panic reaction wasn't justified.

Hurricane seasons are a time when the sugar market gets a lot of attention. There is always the possibility that the crop in some of the sugar growing areas could get blown away and damaged beyond recovery. This could happen, but is rare. Many traders buy options to cover this vulnerable period of time, looking to profit. Though over the long haul, more precise timing is required to cover the option premium expenses.

A great strategy for sugar is buying a call and selling another call at a higher strike price to cover some of the premium expenses. (spread) Also, you could buy a futures contract and buy a cheap put as protection. And finally, sell options in a trading range after a big move. This is a strategy used to capture inflated premiums for profitable erosion.

Sugar has long term "kick-in-the-pants" cycles that produce massive moves every eleven years or so. Keep an eye out for the next one.

Here's how I look for opportunities in the sugar markets: First I generate a TimeLine forecast that shows a strong move up or down in sugar. The TimeLine is based on time cycles and other preprogrammed patterns. I then determine if the move is expected to be choppy, trending, and for how long. This helps us focus on possible directional futures/option positions or writing options in a range, or even writing options with the trend.

Next I use automated option software to search for the best of 1600 strategies based on the expected market move. I compare these option to option combinations against futures to options combinations. At some point I will find a compromise between risk, profit and simplicity in one or two strategies. In hindsight there's always a best strategy we could have used. Keep this is mind when narrowing down the choices. When finished, we want to have one or two potential trades to work with. We call the selected few, "high probability, low risk trades."

Remember there is more to planning a trade than just coming up with a forecast. The market may move as predicted but we can still lose by choosing the wrong trading vehicles. Pick the right vehicles and strategies that will allow us to stay in the market without excessive fear, but still carrying calculated risk.

We NEED to take on calculated risk or the market will not pay us for our services. In addition, the vehicle has to move far enough to make a profit without letting the expense of protection eat us up. Excessive protection (risk avoidance) can come in the form of option premiums, too close-in stop loss orders - and overdone, complex spread strategies. Matching a forecast to a strategy is an important skill to succeed in commodity trading.

Good Trading!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his market forecast TimeLine Trading charts and get his complete 44+ lesson, "Thomas Commodity Trading Course - all free." Main site: