Buy one December Cocoa Futures at or near 1600 and at the same time buy one October Cocoa 1600 put both at the market.

• Market: December Cocoa (CCZ6)
• Tick value: 1 point = $10
• Option Expiration: 09/01/06
• Trade Description: Defined risk swing trade
• Max Risk: $500
• Max Profit: Unlimited

Trade Analysis

In this trade we are looking to capitalize on the momentum building in the cocoa market after it successfully held the support level @ 1515. Although the market has risen off of the absolute lows, as the previous rally shows cocoa has the ability to move substantially in a very short period of time. We are attempting to use this volatility to our advantage by going long at the current levels in the futures market, while purchasing a protective put between 1600 and 1650.

Essentially, the put gives us a bit of breathing room on the entry as the market is accelerates away from support. Furthermore, the option allows us to define our risk when putting on the trade to the premium paid for the put. From a technical perspective the oscillating indicators have given a multitude of buy signals in the last few days, namely; MACD, Acc/Dist, DMI.

The seasonal indicator shows a bit of very short term weakness that may produce a correction before moving higher. Such a correction would allow us to sell the put back at a profit, thus lowering the cost of the position and entering a stop below the strong support level.

Technical Analysis

Exit Strategy

1. If the market falls and stays below 1600 we simply exercise the put and our loss will be the cost of the put.

2. If support does hold and the market does in fact rally we could either exit the put and move a trailing stop in or simply put the stop in and keep the put on in case of a reversal. Again market conditions at the time of exit dictate which exit strategy should be chosen.

We prefer a trailing stops to targets as that will allow us to capture as much of the move as we can.

Profit and Risk Analysis

Max profit is unlimited but our targets are a move back to the recent old highs just above 1750 and then if we break out above that we are targeting 1900.

Max risk assuming a 50 point fill on the put is $500 This occurs at expiration with Cocoa trading below 1600. Break even at expiration, assuming a fill on the put of 50 points, would be 1650.

Derek Frey is Head Trader at Odom & Frey Futures & Options.

Risk Disclaimer 
Past performance is not indicative of future results. Trading futures and options is not suitable for everyone. There is a substantial risk of loss in trading futures and options.