A couple of months back, in the Option Seller Newsletter, we suggested selling calls in the Sugar market as a way to take advantage of a seasonal tendency in prices. If you are not a managed client or did not take this trade on your own, you can look at the price chart below to tell how it performed.

However, as The Byrds once sang, seasons change and so can I. Or so should you.

Sugar is a market that lends itself well to both seasonal and fundamental analysis. And right now, it has strong indicators in both of these areas that suggest prices will be hard pressed to move much lower any time soon. If you are learning how to sell options for income, this is the kind of market you are looking for.

Contract Structure favors Seasonal Bulls

Unlike markets like crude oil, where futures contracts are deliverable in every month, Sugar has deliverable contracts in only four months, March, May, July and  October. That leaves a long time between the last contracts delivered in October and the next ones set for delivery in March.

In the northern hemisphere, the sugar beet crop is harvested through the summer and delivered against the October contract. As supply is often highest at the end of harvest in October, prices tend to reflect this building supply - thus the weaker prices into October/November of this year.

Sugar cane is harvested in the Northern Hemisphere winter. But this supply is not available for delivery against a futures contract until March. This lag in supply can be reflected in higher sugar prices during the early year calendar months. This price tendency has been especially pronounced over the past 5 years  

Record Low Stocks to Usage in 2012

As we have often mentioned in previous articles, the stocks to usage ratio, is one of, if not the most important figure in fundamental analysis of an agricultural commodity. Stocks to usage ratio is the amount of "leftover" supply at the end of the crop year vs. expected demand for the upcoming year.  For instance, if the stocks to usage ratio was 20%, that means that if there was no sugar grown in the whole world in the upcoming year, we have enough supply left over from last year to meet 20% of the upcoming year's demand, before supply runs out.

Despite record sugar production in 2011, 2012 World Sugar stocks to usage will fall to a record low. This indicates an extremely tight supply situation for the upcoming year. Much of this is due to the continued demand growth from China which will see a 2 million ton supply deficit this year.

Sugar ending stocks to usage will hit a record low in 2012, painting an extremely tight supply picture.

Conclusion and Strategy

The combination of a strong seasonal tendency and historically tight supplies makes steady to higher sugar prices a likely scenario over the next 90 days. When or how much higher is anyone's guess. Fortunately, as option sellers, we don't care about such trivialities. The deck is now stacked against a substantial move lower in sugar prices. This makes selling Sugar puts look like a high probability play for income and return seekers in late December/early January.

Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.

James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
Optionetics.com ~ Your Options Education Site