By Noble Drakoln

With a scientific name like Theobroma, which means "food of the gods," it's no wonder that the world can't seem to get enough cocoa. The origins of the cocoa plant can be traced back thousands of years. Discovered during the early exploration of the Americas, cocoa successfully spread across Europe in the 1600s as sweeteners and flavorings were added.

Originally a bitter beverage for the royal court of the Mayan empire, cocoa production has become an international industry. Today, cocoa trees are predominantly grown in West Africa, primarily processed in the Netherlands and the U.S., and cocoa is consumed in one form or another by every country in the world. (Learn the contract specifications for a few of the most heavily traded commodities in The Sweet Life Of Soft Markets.)

A sample commodity futures contract for cocoa is shown in the following table.

Cocoa Contract Specifications
Ticker Symbol Open Outcry: CC (ICE)
Electronic: ECC
Contract Size 10 metric tons
Deliverable Grades
The growth of any country or clime, including new or yet unknown growths. Growths are divided into three classifications listed below
Group A: Deliverable at a premium of $160/ton (includes main crops of Ghana, LomeNigeria, Ivory Coast and Sierra Leone)
Group B: Deliverable at a premium of $80/ton (includes Bahia, Arriba, Venezuela, Sanchez and others)
Group C: Deliverable at par (includes Haiti, Malaysia and all others)
Contract Months H (March), K (May), N (July), U (September), Z(December)
Trading Hours Monday-Friday
Last Trading Day One business day prior to last notice day
Last Delivery Day Last business day of the contract month.
Price Quote Dollars per metric ton
Tick Size $1 per metric ton, equivalent to $10 per contract
Daily Price Limit
(Not applicable in electronic markets)

Understanding Cocoa Contracts
Like every commodity contract, cocoa has its own ticker symbol, contract value and margin requirements. To successfully trade a commodity, you must be aware of these key components and understand how to use them to calculate your potential profits and loss.

For instance, if you buy or sell a cocoa futures contract, you will see a ticker tape handle that looks like this:

CC8K @ 1363

This is just like saying "Cocoa (CC) 2008 (8) May (K) at $1,363 per metric ton (1363)." A trader buys or sells a cocoa contract according to this type of quotation.

Depending on the quoted price, the value of a commodities contract is based on the current price of the market multiplied by the actual value of the contract itself. In this instance, the cocoa contract equals the equivalent of 10 metric tons multiplied by our hypothetical price of $1,363, as in:

$1,363 x 10 metric tons = $13,630

Commodities are traded based on margin, and the margin changes based on market volatility and the current face value of the contract. For example, to trade a cocoa contract on the Intercontinental Exchange (ICE), a trader may be required to maintain a margin of $2,660, which is approximately 19.5% of the face value.

Calculating a Change in Price
Because commodity contracts are customized, every price movement has its own distinct value. In a cocoa contract, a $1 move is equal to $10. To determine ICE's cocoa profit and loss figures, you calculate the difference between the contract price and the exit price, and then multiply the result by $10. For example, if prices move from $1,363 to $1,400, you multiply the difference, which is $37, by $10 to yield a contract value change of $370.

- Buy Sell Total Value
Cocoa Contract Price ($1 move = $10) $1,363 $1,400 $37 or $370

Cocoa Exchanges
The futures contract for cocoa is traded on the Intercontinental Exchange (ICE) and NYSE Euronext.

Facts About Production
The cocoa plant requires a very specific set of circumstances to thrive and prosper. As a small evergreen tree that can become 15-26 feet tall, it can only grow in regions that are 20 degrees north or south of the equator. Naturally, there are very few places on earth with the right climatic factors for the cocoa plant to thrive, and West Africa has emerged as the dominant player in cocoa production, with approximately 70% of the market share in 2008.

There are two distinct types of cocoa plants: Criollo and Forastero. The Criollo variety is the most sensitive of the cocoa plants, and any shifts in climate can have an adverse affect on its already low yield. In an attempt to blend the hardiness of the Forastero plant with the delicate flavors of the Criollo plant, the two were hybridized into a third plant, Trinitario, which accounted for 20% of all production in 2008, although it's steadily developing a following.

Regardless of the cocoa variety, the production cycle is the same. On average, cocoa trees take five years to reach maturity and bear fruit, at which time only a total of about 20 pods might be ready for harvest. As a rule of thumb, 10 pods produce 2.2 pounds of cocoa, so the average tree can produce only a little over four pounds of cocoa. Interestingly, the Ivory Coast, Ghana and Indonesia account for more than 70% of the world's cocoa production, and most of that production comes from small farmers.

Factors That Influence Cocoa's Price
The price of cocoa is influenced by the following factors:
  • While bees and butterflies are common pollinators, the cocoa flower is pollinated by midges, small flies or by hand. Global climatic shifts are presumed to have an effect on bee colonies around the world, and the midge fly could be affected by similar environmental pressures.
  • In 1983-1984, cocoa production reached a respectable production level of 1.5 million tons. Twenty years later, in 2003-2004, cocoa production had doubled. Unfortunately, this has occurred not because of advances in agricultural efficiency, but because more land was allocated to cocoa plantings. With much of the cocoa production occurring in politically unstable areas such as the Ivory Coast, Ghana and Indonesia, political factors have a disproportionate influence in cocoa price stability.
  • Temperatures for optimum growth range from just 69-90 degrees Fahrenheit, or 21-32 degrees Celsius. Temperatures lower than 59 degrees (15 degrees Celsius) can be fatal. What's more, cocoa trees need no more than 2,000 millimeters of annual rainfall. Combined, these factors leave the cocoa tree vulnerable to global warming.
  • A few companies control much of the world's chocolate. Barry Callebaut, Cargill and Archer Daniels Midland Company (NYSE:ADM) are all industry giants. Other major corporations, including Mars and Cadbury (NYSE:CBY), as well as several small chocolatiers, are beholden to the financial and political decisions of the three controlling companies.
  • The International Labor Organization released a report in 2005 stating that cocoa farms on the Ivory Coast are exploiting thousands of children in order to keep their industry thriving. According to the report, up to 200,000 children in 2005 were working in cocoa fields under terrible conditions, with a small percentage of them victims of human trafficking.
Cocoa was originally blended into a drink meant solely for royalty. Today, it can be found in lotions, beverages, confections and more. The demand for cocoa criss-crosses the globe, while the supply is limited to only a few places on earth. The need to find a balance between supply and demand, along with cocoa's long gestation period, leaves considerable room for price discovery at any given time.

Next: Commodities: Coffee »

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