T AMPA () — For those unfamiliar with the growing seasons of coffee, it’s early autumn in Brazil and the time of year when speculators often start buying coffee calls in hopes of a Brazilian freeze driving up coffee prices once winter arrives. And why not buy calls?

After all, in addition to winter freeze fears, there are plenty of other reasons to be bullish coffee. The 2006/2007 Brazilian crop is projected to be the smallest in 7 years, with an expected yield of roughly 31.5 million bags of beans according to the latest government estimates.

There are now quality concerns creeping into the market as well, as many traders feel heavy rains in certain growing regions will hamper bean development. In addition, coffee prices have been in a relentless downtrend for several weeks, bringing prices to levels that many feel are cheap.

To some traders, buying calls in coffee may seem like a lucrative opportunity at this time.

We feel quite the opposite.

To understand the trading opportunities present, we must first understand the fundamentals. In reviewing these key determinates of price, we can understand why coffee prices are at their current levels and why they are unlikely to push anywhere near the strikes currently available at which to sell call premium.

Coffee is one market that is very favourable to fundamental trading. There are a few producers that make up the majority of production. Crop figures and demand estimates are available 6-12 months out and can be projected somewhat accurately. If one can focus on these big picture numbers and tune out the daily noise, one can compare them to supply and demand of past years and their corresponding price levels. This may not tell us exactly where the market is going to go. But it can give one a fairly clear idea of where the market most likely will not go. And as option sellers, that is all we need.

While coffee is grown in many countries across the globe, Brazil is the worlds largest producer and exporter of coffee by far, responsible for approximately 1/3 of the world’s total coffee production in any given year and accounts for the majority of the higher quality arabica coffee traded at the NYBOT. Thus developments in the Brazilian crop have a substantial impact on coffee futures prices at the NYBOT.

As we approach the beginning of the 2007 Brazilian coffee harvest (in May) market talk will turn to the subject of freeze season. Yet, while freeze season may get a lot of hype in the press, the chances of a freeze causing significantly damage to the Brazilian Coffee crop have dropped significantly in the last 10-12 years. After crop damaging freezes in the early and mid 90’s, Brazilian producers began a trend of planting replacement trees further north towards the equator in regions such as Minas Gerais and Sao Paulo. This effectively transferred production to a more moderate winter climate, and out of more frost prone zones.

While the chances of a crop damaging freeze can never be completely eliminated, it is our opinion that this is such a significant fundamental change that the speculator buying often seen in May could become a non-factor within the next 4-5 years.

Even before this change in growing areas, a sustained summer price rally in coffee has been an extremely rare exception to the norm. Normal seasonal averages generally see coffee experience a short rally in May as bullish speculators buy the market. This will often be followed by a sustained regression in prices as new Brazilian supply works its way to market just when the Northern Hemisphere heads into the lower consumption summer months.

This year’s lower crop figures should be given their due. After all, it is a substantial decrease from the massive 43 million bag harvest in 2006 and some analysts expect Brazilian coffee exports to drop as much as 10% in 2007 as a result.

While this may be true, this viewpoint does not take into account the massive supplies in storage left over from the 2006 harvest. The South American coffee harvest typically wraps up in October. Yet Brazil and Vietnam are still aggressively marketing their excess 2006 supplies in an effort to clear warehouses to accommodate the 2007 crop.

This is the primary reason for the recent downtrend in coffee prices. The market must adjust for the world’s two top producers flooding the market with excess supplies. Think of an automobile dealership blowing out the 2006 inventory to make room for the new 2007 models and you will have a fairly accurate metaphor for what is happening on the world coffee export market right now.

Does this mean that prices will rally once the market begins to price the 2007 crop? Possibly. But we do not feel prices can rise substantially. Excess inventories from 2006 should pare down demand for 2007 beans for some time as roasters stock up on supplies at current price levels.

In addition, the moisture concerns that have crept into the news as of late could actually be a longer term bearish issue for coffee. For while excess moisture may or may not hamper quality in certain regions, autumn rain produces vibrant, healthy coffee trees which will bode well for the October flowering. The October flowers are what eventually turn into 2008’s coffee beans. Many coffee analysts and industry panels are projecting 2008’s Brazilian harvest to be massive, possibly eclipsing 2003’s record 53 million bag yield.

Sandwiched between last year’s excess supply and the possibility of the largest Brazilian coffee harvest ever in 2008, we feel any price increases related to the 2007 crop will be short lived and benign.

Prices, however, can move quickly up and down in the short term and can make futures trading treacherous business in coffee. This is why we recommend selling calls as an excellent strategy for taking advantage of this volatility. Selling calls allows traders to ride out short-term swings in the market without being forced out of position.

The seasonal interest of small speculators in buying cheap call options at absurdly high strike prices (when one considers the fundamentals), has driven demand, and therefore premiums on these options to attractively high levels. Speculator interest in calls makes it possible now for an astute option seller to collect substantial premiums for calls at strike prices nearly double the current price of coffee. This means that coffee prices would have to increase by nearly 100% over the next 16-20 weeks for these options to ever trade in the money.

If there is anything I have learned in my 20 years of trading, it is to bet against the small speculator, and side with the commercial trader. This approach has proven most effective in the flexible strategy of option writing. Speculators can move the market temporarily on momentum and media hype, but the commercials bet on the long term fundamentals. As an option seller, you should too.

Nonetheless, the market is currently oversold and we do expect to see some seasonal spec buying coming into the futures market over the next 30 days. We would view limited rallies in coffee prices as call selling opportunities as commercials should be eager to hedge their crops before the market starts eying the prospects for 2008 production.

James Cordier is head trader and president of Liberty Trading Group. a futures brokerage firm specializing in option writing on commodities. Michael Gross is an analyst with Liberty Trading Group .