Sugar

SWEET DEAL: Selling put options on sugar

Have you ever wondered how to trade sugar? It is quite easy, all you have to do is to gather some information. One possibility might be selling put options.

Allow me a little introduction first. I started this blog to share my journey towards financial independence. The best way I have found for myself to achieve independence is through financial markets, be it trading or investing. Currently, the sugar market raised my attention because I see there good opportunities for an option seller.

Sugar is traded at the Intercontinental Exchange (ICE) under the symbol “SB”. The symbol helps us to find the relevant futures contract or the relevant option in the trading account. Here, we are speaking about the most commonly traded futures contract – sugar No. 11 – which is raw cane sugar. Sugar as a commodity belongs to the so-called “softs” together with coffee, cocoa or cotton. We might call them also exotics because of where they grow. One future contract includes 112,000 pounds of sugar. This means, one contract would be more than enough for a life-long-supply for the whole family. However, for what we do as small traders, we do not want any physical delivery of sugar. Nowadays, the majority of brokers do not allow physical delivery anyway. Speaking about futures, there are sugar contracts for four different months: March, May, July and October.

This was the basic overview of sugar futures for my trade. Actually, I do not trade the futures contract themselves because I focus on selling options in the sugar market, in this case put options. To find out more about options in general, check out the “OPTIONLAND”.

Indeed, I am going to sell a put option on sugar, as I expect that the price of the March sugar contract won’t go below a certain level, to be precise below 0.13 in the next 54 days. Why am I doing it? Let’s look at the reasons together:

Fundamental analysis

It is always good to have some basic information about the factors influencing the supply and demand in the sugar market so that one can understand how price for sugar is being created. I personally consider just the very simple fundamental analysis to have at least the basic picture about how the market looks like. To focus on detailed fundamental analysis might be good for a large company producing sugar, market analyst employed by Coca-Cola or for a full-time employee working in a hedge fund trading just a few markets. I do not say that fundamental analysis is not important, but for me as an option seller, trading a number of markets, too detailed analysis is not the most effective way forward.

Let’s have a brief look at the basics. Sugar cane grows in tropical climate and Sugar caneneeds plenty of water. Among the biggest producers of sugar are Brazil, India and Thailand. Hence, it is useful to know about the weather conditions in those countries. When the harvest of sugar cane is good, there will be high supply of raw sugar and this might result in decrease in price. Currently, the projections estimate quite a good harvest in Brazil and that is one of the elements why the price of sugar is already low. In India, there is currently the monsoon season and it seems that there is less rain that it would be ideal for sugar. Therefore, that might boost the prices a little bit, supporting our put option selling idea.

Another important fact to consider is how much of the harvested sugar cane will be used to produce sugar and how much to produce ethanol. Some pirates among us might be smiling, thinking of rum, but ethanol derived from sugar is increasingly used as a fuel. In Brazil, there are currently some discussions about changing tax policies to favour more the production of ethanol.

You might see that following the fundamental data might be quite complex. Fortunately, you do not have to be on-site measuring the rainfall and looking for cane beetle which might damage the crop. I use a little trick with the help of Commitment-of-Traders Report, which I found in the book wrote by Larry Williams. Some players on the market have so large positions that they must report how many contracts they trade. One such group is called “commercials” and those are the people with substantial knowledge about the sugar market. Commercials are companies which actually use sugar as their core business, be it sugar producers or companies which use sugar in their products, for example sweets or drinks. At the moment, the commercials are bullish and that is what matters for me, when selling put options.

Technical analysis

Although sugar is still in down trend, it looks like it is building a double bottom. There is a support zone at approximately 14.00 and at the moment, the price does not want to go through. This is a very simple signal indicating that price might be stable at the moment and eventually raise. We do want our put options to stay out-of-the-money.

Price chart of sugar explaining why selling put options
Sugar chart showing a support zone

The seasonal chart also indicates that sugar is near the bottom at this time of the year. It might decline a little bit in the next weeks, but as from the end of September, sugar price shall start to raise.

Seasonal chart of sugar explaining why selling put options
Seasonal charts of sugar showing the price developments in different months throughout the year

Last but not least, it is important to look at the implied volatility, which is currently quite high. These are excellent conditions for an option seller. In simple words, implied volatility shows how high the demand for options is. The higher the demand, the more expensive are the options. Thus, the premium received by the option seller, for the put options, is lucrative.

Summary

I see an opportunity to selling put options on sugar “SB” expiring in Nov’17 at the strike price 0.13 while collecting a premium of app. $145 per option.

Advantages of the trade:

  • Implied volatility rank of sugar is high, which means that option sellers will currently receive a high premium;
  • Commercials are bullish;
  • Seasonally, the price might decline a little bit, but as from the end of September, it shall start to raise;
  • It looks like sugar is building a double bottom and stopped declining at a support zone.

Challenges:

  • The ICE subscription to have real-time data for sugar is expensive. Hence, many individual traders will be forced to use delayed data;
  • The difference between ask price and bid price might be a bit wider causing some slippage. It means that when one sells the option for $145 and you want to buy it immediately back, it would cost you at least $156 up to $168, in other words the difference between the sell and buy price. This is however the case for many agricultural commodities and sugar is definitely still tradable.

What do you think about this market idea to sell put options on sugar?



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