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Consumption of This Hot Commodity Is Up 1,800% in South Korea

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This market could be setting itself up for a big wake-up call in 2013, especially thanks to a growing coffee culture in Asia.

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Wake Up and Smell the Opportunity

Given the severity of next year's supply situation, it would not surprise us to see prices begin to anticipate a coming shortage. Our initial target is a Fibonacci retracement of 38% of last year's down move that would bump prices back up to roughly $2 in the July futures contract.

Coffee options trade on the electronic Intercontinental Exchange (ICE). Each option contract covers 37,500 pounds of premium Arabica beans. Both the future and option contracts trade in dollars and cents, making each one-tenth of a cent "tick" or "point" worth $3.75.

An aggressive, fixed-risk way to play this market is to buy July $1.80 coffee calls while simultaneously selling an equal number of July $2 coffee calls for a net cost of 220 points ($825) or less. This is a professional trading strategy known as a "bull call spread." Buying the $1.80 call gives us the right, but not the obligation, to be long 37,500 pounds of coffee at a price of $1.80 per pound. We pay money for this right.

Selling the $2 call puts money in our pocket in exchange for our obligation to sell coffee at $2 per pound. We use this money to help offset the cost of our long $1.80 call. We've now mated the right to be long at $1.80 with the obligation to be short at $2, and that means we can make the full 20 cents or 2,000 "points" between the two strike prices. 2,000 points times $3.75 per point equals $7,500. Using a bull call spread rather than buying a call outright lowers the cost of our bullish option play dramatically.

If filled at our suggested price of 220 points, our maximum risk is $825 plus transaction costs. We can gross as much as $7,500 should coffee wind up at or above our $2 price objective on or prior to option expiration on June 13.

Editor's Note: This article was written by Stephen Belmont in World Money Analyst.

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