What is the Best Futures Trading Strategy For Coffee?
StartupStockPhotos / PixabayThe coffee market is thriving right now, with good weather conditions making for abundant crops and steady imports, but even with a bumper crop expected later in the year, commodities traders need a smart futures strategy to deal with inevitable fluctuations. But what’s the best approach?
In order to protect your investment and increase your odds of a profit, you’ll need to focus on spread trading, but even that offers a few different possibilities when it comes to coffee.
These 3 approaches to the coffee futures each offer different potential benefits and protective effects, but you’ll need to assess your investment preferences to select the right one for your portfolio.
An All Coffee Spread
One of the advantages to investing in coffee is that you can build a commodities spread exclusively from coffee if you want to. Though spreads typically rely on multiple types of commodities such as combining wheat, corn, and oranges, different varieties of coffee respond differently to market influences. In mid-May, for example, Vietnamese growers refused to sell, waiting on higher prices, while with such good weather, New York’s Arabica futures were especially low.
If you’re considering an all-coffee spread, it’s important to be familiar with what varieties attract the same buyers. Robusta and Arabica protect each other from a market perspective because they’re largely interchangeable, and while there are other kinds of coffee in production, they aren’t traded as widely as either of these.
Though coffee obviously has a growing season, it’s popular year round, and that can have a significant impact on futures prices. From where we’re standing right now, though, coffee will likely flourish for the next few months and that means low contract prices. This state lends itself well to a contango approach, with forward contracts more valuable than the spot price. On the other hand, when traders are worried about winter storms freezing upcoming crops, it may be better to switch to a backwardation strategy.
Another alternative from a seasonality perspective is to build your spread based on growing seasons. For example, May cattle and hog prices are down, likely because last year’s births are ready for slaughter. On the other hand, orange contracts are up significantly over the last few months, making them a good buy to counter livestock.
Split The Exchange
One of the interesting things about trading contracts and grappling with seasonality is that the same commodity may trade at different prices on different exchanges. You can take advantage of historic market lags by trading on multiple exchanges.
Though this tends to work best with crude oil, other commodities including coffee can take advantage of price gaps. Coffee trades on both the CME and ICE and with slightly different calendars on each and smart futures traders can play the two against each other.
Spread trading is the futures answer to ETF, except you get to build your own “fund.” If you’re playing this long game, play it smart and build beyond coffee. While playing Robusta and Arabica or the CME and ICE indices against each other, you can also use this approach as a component of seasonal, multi-commodity spread trading.
Most importantly, though, don’t be afraid to make an intuitive leap. The willingness to take a backwardation approach or play a bull market against itself is ultimately what makes a great investor.