• Market:  January 2007 Coffee(KCH7)**Jan options trade based on the March futures contract.
• Tick value: 1 point = $375
• Option Expiration: 11/21/06   
• Trade Description: Bull call spread
• Max Risk: $750
• Max Profit: $3000
• Risk reward ratio:  4:1

Buy one January 2007 Coffee 110 call and at the same time, sell one January 2007 Coffee 120 call for a combined cost and risk of 2.00 points ($750) or less to open a position.

Technical / Fundamental Explanation
For some time now I have been talking about the fact that we are seeing "sector rotation" in commodities. By this I mean that the early leaders of the bull run will correct while the laggards will "catch up". This will keep the the CRB index moving in a overall sideways fashion. We are now clearly seeing this come to fruition. Metals and Energy have been the leaders and since spring both are significantly off of their highs. In that same time we have seen grains rally quite significantly. I am now predicting that the softs will be the next group to see sharp rallies. The wild rally we saw in OJ today only strengthens that argument. So all of this brings me now to coffee which is traditionally one of the more volatile commodities that we trade. In the chart below you can clearly see that we are seeing this market build both a short term and at the same time long term coil pattern which is often the precursor to a breakout. Since volatility is low and we are anticipating a break out to new highs a long options strategy is what we suggest. This is a simple bull call spread that keeps risks in check and at the same time gives us a realistic shot at getting 4 to 1 on our money.

Profit Goal
Max profit, assuming a 2.00 point fill, is 8.00 points ($3000) and occurs with March 2007 coffee trading at or above 1.20.

Risk Analysis
Max risk, before commissions and fees, and assuming a 2 point fill, is $750. This occurs at expiration with Coffee trading below 1.10.

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

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.