Trade Description
Buy two July coffee 120 calls & sell one September Coffee 120 call for a credit of 2.40 ($900) or better.  Margin is approximately $300 but can fluctuate depending on price, time and the spread difference between July and September futures.  July coffee options expire on 6/9/06 and the September options expire on 8/11/06.  The September option is not intended to be held past the July option expiration.

Explanation
A consolidation pattern has developed, along with a potential rounding bottom formation, after a seasonal retracement in coffee.  The market is primed to rally off of strong technicals and a pre-frost season short covering rally.  The trade design benefits from out of whack time premium valuations between the September and July call options and plays on the idea that we will see a coffee price rally over the next 6 weeks.

Profit Scenarios
Max profit is unlimited, however profit scenarios on a trade like this are tricky because the price of the underlying futures could change over time and change the option pricing.  Profit occurs in two main places.  First, if the market rallies then once the July futures break through 120 the ratio of two long calls to one short call begins to create a profit of approximately $375 per full point above that price, although it does depend on the time to expiration and the futures spread - the exact price in which that occurs is near 120 (but cannot be specifically defined).  Secondly, if the market sells off significantly then premiums in both the July 120 calls and the September 120 calls disappear and the potential for some or all of the credit on the trade to be received is created.  In summation, this trade ideally profits on a surge higher in prices over the next six weeks but can also profit from a major price move in either direction due to the credit received on the trade.

Risk Scenarios
Loss scenarios on this trade are not completely defined, but there are several important factors to note.  First, the margin requirement is approximately $300, which suggests the exposure to wide moves in the underlying futures spread and the overall exposure to any price move is fairly minimal compared to a futures contract that carries over $2,000 in margin.  Second, the position is hedged up until the expiration of the July options, and the trade is intended to be completely covered at or before that time (by buying back the September call), so as to avoid net short option exposure.  Last but not least, the ratio of two long calls to one short call offsets a majority of the potential futures spread exposure.  Additionally, the historical volatility of the July futures versus September futures is minor.  It is recommended to cover the position if losses exceed $650.

James Mound is the head analyst for www.MoundReport.com, and author of the commodity book 7 Secrets. For a free email subscription to James Mound's Weekend Commodities Review and Trade of the Month, click here.

Disclaimer
There is risk of loss in all commodities trading.  Commissions and fees vary per individual and therefore are not included in profit, cost and risk scenarios.  Please consult a licensed broker before you trade for the first time.  Losses can exceed your account size and/or margin requirements.  Commodities trading can be extremely risky and is not for everyone.  Some option strategies have unlimited risk.  Educate yourself on the risks and rewards of such investing prior to trading.  James Mound Trading Group, or anyone associated with JMTG or moundreport.com, do not guarantee profits or pre-determined loss points, and are not held monetarily responsible for the trading losses of others (clients or otherwise).  Past results are by no means indicative of potential future returns