The sugar trade is romantic! Here are some valuable tips and problems taken from real 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 $1,200 will control about $13,000 worth of sugar. (112,000 pounds at 12 cents per pound) A penny movement in sugar equals $1120.
Brazil is now energy independent from its use of ethanol in the form of alcohol. Ethanol is derived from sugar. This has caused a huge increase in the number of commercial speculators and hedgers trading sugar futures and options. The volatility and liquidity generated is a positive by-product.
Sugar trading for just three hours a day, from 9 am to 12 pm What a great life to be an expert sugar trader! It’s a fifteen-hour work week.
Sugar has made several extreme moves in the last thirty-five years. The last big move to 18 cents a pound was last year. In the early 1980s, sugar fetched 44 cents a pound. In the early 1970s, sugar hit 66 cents!
On the other hand, the ounce of sugar fell to 2.5 cents a pound. The entire 112,000 pound contract was worth just $2,800! You could have received it and stored it for a few years and sold it for 15 cents a pound or $16,800. (Or just went ahead with no-delivery contracts) That’s not a bad win if you thought sugar wasn’t going to be free. Multiply this by ten contracts and you’ll get over $160,000 on a $30,000 investment. There is certainly opportunity if one is willing to take the risk.
During normal or quiet markets, options on sugar futures are usually cheap and you can buy long. Strategies are plentiful for spreads, straddles and strangles. Sugar creates many long-term patterns and formations. Wave analysis and swing trading work well for sugar when it is trending.
Some traders look to the possibility of “pyramid” 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 future positions using previous profits. Never forget that this is a double edged sword. If you add positions, be sure to adjust for catastrophic stops so your losses aren’t out of control if the market reverses. If the market stops you and moves in the other direction, don’t be afraid to re-enter if the trend is still intact. Sugar trends may last much longer than most expect.
Look for exit positions after big moves during the morning open or near the close. Sugar futures tend to reverse after very large moves and open the next day. Try not to hold big gains over the weekend thinking Monday morning will have a big following. You may want to relax on Friday just before closing.
If you feel nervous about holding big profits, my best advice and rule of thumb is to hold half your position and sell the other half. This way, you can never be more than half wrong and half right. This is a form of “scaling”, which is one of my favorite techniques. Also, following a weather move, option prices are often highly inflated. Option premiums may actually decline on a flat open on Monday because the earlier panic reaction was not warranted.
Hurricane seasons are a time when the sugar market gets a lot of attention. There is always a chance that the crop in some of the sugar growing areas could be blown away and damaged beyond recovery. This could happen, but it is rare. Many traders buy options to cover this vulnerable time period, in search of profit. Although in the long run, a more precise timing is required to cover the cost of the option premium.
A great strategy for sugar is to buy a call and sell another call at a higher strike price to cover some of the premium expense. (spread) Also, you could buy a futures contract and buy a cheap put option as protection. And lastly, selling 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. Stay tuned for the next one.
This is how I look for opportunities in the sugar markets: I first generate a timeline forecast that shows a strong move up or down in sugar. TimeLine is based on time cycles and other pre-programmed 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/options positions or write options in a range, or even write options with the trend.
I then use automated options software to find the best of 1,600 strategies based on expected market movement. I compare these option-to-option combinations to futures-to-option combinations. At some point I will find a compromise between risk, reward and simplicity in one or two strategies. In hindsight, there is always a better strategy we could have used. Keep this in mind when narrowing down the options. When it’s done, we want to have one or two potential exchanges to work with. We call the selected few “high-probability, low-risk trades.”
Remember that there is more to planning for an operation than simply making a forecast. The market may move as expected, but we still stand to lose if we pick the wrong commercial vehicles. Choose the right vehicles and strategies that allow us to stay in the market without excessive fear, but still with calculated risk.
We NEED to take a calculated risk or the market will not pay us for our services. In addition, the vehicle has to move enough to make a profit without letting the protection expense consume us. Excessive protection (risk avoidance) can come in the form of option premiums, stop loss orders that are too close, and complex and exaggerated spread strategies. Matching a forecast to a strategy is an important skill for being successful in commodity trading.
Happy trading!
There is substantial risk of loss in futures and options trading and may not be suitable for all types of investors. Only risk capital should be used.