Cattle Crush Spread: Reentry Signal Triggered

Cattle Crush Spread

Yesterday the August-April-May 6:3:2 cattle crush spread closed above the declining 30-day Moving Average for the first time in over two months. This signaled a bullish trend change and a reentry signal for the blog.

The spread closed at -$10,860 (premium the sum of the feeders and corn) on October 27th. Therefore, the blog hypothetically purchased six 40,000 lb. August 2015 live cattle contracts at 153.60 (total value of $368,640), sold three 50,000 lb. April 2015 feeder contracts at 227.30 (total value of $340,950), and sold two 5,000 bushel May 2015 corn contracts at $3.85 1/2 (total value of $38,550). Initially, the exit strategy is to liquidate the spread on a two-consecutive day close below -$20,750 (just over $500 below the current contract low).

August-April-May Cattle Crush spread daily

August-April-May Cattle Crush spread daily

The first attempt to get long resulted in a loss when the August-April-May 6:3:2 cattle crush spread collapsed to a new contract low and even traded below the 2011/2012 double bottom lows on the weekly nearest-futures chart. This double bottom was an all-time low for the front month cattle crush spread, by the way. Long-term, this spread cannot stay inverted as it would mean that the live cattle are trading below the cost of production. Only the US government can get away with operating in the red year after year!

Once the August-April-May 6:3:2 cattle crush spread gets back above ‘even money’ we will be watching for setups to add to the long position.

 

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Campaign Trading: Maximizing Profits with Interval Ladders

Potential Topping Action

The T-bond/T-note spread is getting interesting here. On the weekly timeframe, a double top could be forming between the late August high of 15-06.5 and the mid-October high of 15-08.5. Coincidentally, this potential double top is forming just a few ticks shy of the 2013 weekly high at 15-14. A break below the weekly mid-September correction low of 12-19 without scoring a new high first would confirm the double top.

T-bonds T-notes spread weekly

T-bonds T-notes spread weekly

Don’t forget that we previously discussed how an end-of-week close below the weekly 20-bar Moving Average (likely to be around 13-11 next week) for the first time since the start of the year would signal a bearish trend change. This would occur before double top is confirmed. If so, this US Treasury spread could be in for one heck of a decline.

Full Court Press

If the interest rate spreads are on the cusp of a major trend change, it’s high time that traders get a game plan together in order to maximize the opportunity. There are different ways to skin a cat, but I want to discuss a personal preference that has worked well for me.

It may first appear counter-intuitive, but I would add to the short interest rate spread position only as the price is declining. Sell more into weakness, not on strength. There’s no dollar-cost averaging when prices move adversely during this sort of trading campaign. It’s purely about momentum. We only want to press the advantage when the market proves us correct by moving in the anticipated direction.

Climbing a Ladder

One method I like to employ for adding to a position is to create a price interval ladder. A series of progressively higher (or lower if you are trading the short side) price targets are set ahead of time for the spread to get to. Each time the spread can meet the target a new position is added. At the same time, the price liquidation levels are trailed for all of the other positions accumulated up to that point. As the market continues to ‘climb the ladder’ more positions are added and the price liquidation levels for all the other positions are raised as well. That way you are increasing the position size while still keeping the risk in check. That’s theoretical, of course. Markets can sometimes blow right through your liquidation levels and leave you hung out to dry. This is why you should also consider capping the amount of ‘add-on’ signals you are willing to take.

Determining the Price Intervals

There are many ways one can determine the interval spacing for the price ladder. One simple way I like to do this is to determine what size of volatility the spread has seen up to that point and use an interval progression that is a bit larger than what we would expect from random noise in the market.

For instance, if the daily swings or counter-trend moves are $1,000 then buying in price intervals of $500 would likely result in a lot of activity and a lot of losses. This is because the spread can easily fluctuate twice that amount without ever making any progress on the trend. However, buying in price intervals of $1,500, $2,000, or even greater will have less activity but have a much higher probability of success. This is because the interval size is bigger than the typical fluctuations in the market and is more likely to be meaningful when achieved.

Updated Trade Strategy for the T-bond/T-note spread

Previously, the blog was working a hypothetical trade to sell one December T-bond contract and simultaneously buy one December T-note contract if the nearest-futures spread makes an end-of-week close below the weekly 20-bar MA (by at least one-quarter of a point). Let’s revise this and put the price interval ladder strategy to work.

After bottoming at the bear market low on November 20th the nearest-futures T-bond/T-note spread has risen just over eleven full points in eleven months. Between November 20th and the end of August, the pullbacks in this uptrend were between one and a one and a half points in size. The two and three-quarter point break from the August 28th high finally allow the spread to break rank and trigger a false trend change signal.

T-bonds T-notes spread daily

T-bonds T-notes spread daily

Tossing aside that big decline into the September low, none of the other counter-trend moves this year exceeded one and a half points. Therefore, we would employ a price ladder with intervals that are two and one-quarter points apart. This is 50% larger in size than all of this year’s other pullbacks. It should keep us outside of the random fluctuations.

Trade Parameters:

The blog will now work a hypothetical trade to sell one December T-bond/T-note spread on a close below 14-00 (premium T-bonds). If filled, the position will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the entry price. Add additional spreads (single contracts for sake of simplicity) on closes 2-08 lower than the prior entry price until a total of four units (the initial entry plus three ‘add-ons’) have been accumulated. For a trailing stop, all units will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the most recent entry price.

Arabica/Robusta Coffee Spread: Trade Signal Triggered

Arabica Coffee/Robusta Coffee Spread

Yesterday we did a post on the spread between the Arabica coffee and Robusta coffee. Although the spread is historically expensive, we noted that previous excursions to these heights have often seen a continued surge several thousand dollars higher before the final peak and reversal occurred. Therefore, we advocated the idea of using a reversal system to jump in either way.

We hit the ground running as the downside parameters for a short sale was triggered at today’s close. Boy, that was quick! The blog initiated a hypothetical trade to sell one 37,500 lb. March Arabica coffee contract at 203.50 (contract value of $76,312.50) and simultaneously buy four of the 10-tonne March Robusta coffee contracts at 2069 (contract value of $20,690 each or $82,760). This puts the short spread position on at a net price of -$6,447.50 (premium the sum of the Robusta contracts).

March Arabica Coffee Robusta Coffee Spread Daily

March Arabica Coffee Robusta Coffee Spread Daily

Initially, the exit strategy is to liquidate the short March Arabica coffee/Robusta coffee (x4) spread position on a close above -$2k (premium Robusta). Also, a close above -$2k will trigger a buy signal to initiate a long spread position. This is because the reversal system always has a position in the market, switching back and forth from long to short if the parameters are elected. Closes above -$2k trigger the buy signals and closes below -$6k trigger the sell signals.

At the moment, it appears that an ominous-looking double top is forming on the daily timeframe between the early March and mid-October highs. If so, a return to last year’s low of -$22k is possible.

Conversely, a breakout to new contract highs from here would destroy the double top pattern. This could send the March Arabica coffee/Robusta coffee (x4) spread skyrocketing above +$10k (premium Arabica) like we’ve seen in the past. Either way, a sizable move could be underway.

Euro Bund/T-note Spread: Trade Signal Triggered

Euro Bund/T-note Spread

I’m more than a week late getting this out, but the December Euro bund/T-note spread triggered a bearish trend change signal on Friday, October 10th when it made the first end-of-week close below the rising weekly 15-bar Moving Average since mid-October of last year.

A hypothetical trade for the blog was triggered to sell one December Euro bund contract and simultaneously buy one December T-note contract at 23.85 (premium bund). Initially, the exit strategy is to liquidate the spread on a two-consecutive day close above 25.16 (premium bund).

Euro Bund T-note Spread Weekly

Euro Bund T-note Spread Weekly

In the past, major reversals in the Euro bund/T-note spread have been followed by a new trend that lasts a year or two. Sometimes even longer. If this really is the big trend change, traders should have plenty of time and opportunity to increase the position size if the spread continues to move south. We will keep you updated as the situation plays out.

Arabica vs. Robusta: Will This Coffee Spread Perk Up More or Will It Get Creamed?

Arabica Coffee/Robusta Coffee Spread

The Arabica coffee contract and the Robusta coffee contract are highly correlated. Even though the Arabica beans and the Robusta beans are grown in different places and are different grades of coffee (the Arabica is the ‘good’ stuff that you drink at Starbucks and what-not while the Robusta is the ‘cheap’ stuff used to make instant coffee), the price of one market is closely tied to the other.

Arabica Robusta Coffee overlay weekly

Arabica Robusta Coffee overlay weekly

Over the last couple of decades the peaks and troughs in the Arabica and Robusta coffee markets occurred around the same time. The explosive bull market rallies and devastating bear market declines in one market was accompanied by a similar move in the other market. Choppy multi-month trading ranges in Arabica or Robusta kept the other market held hostage in a trading range as well. These two markets are joined at the hip as the correlation is undeniable.

Historical Extremes

The ratio between the value of one 37,500 lb. Arabica coffee contract and one 10-tonne Robusta coffee contract reached nearly 3.9:1 when the recent spread contract high was posted on October 14th. This level is getting up there. A ratio of 4:1 or higher has only been achieved four times in the last few decades. However, the last four times it reached 4:1 the ratio hit a blow-off phase and surge further before the final top was made.

March Arabica Robusta Coffee ratio daily

March Arabica Robusta Coffee ratio daily

After breaching 4:1 in late 1996 the ratio rocketed to 5.8:1 before rolling over and crashing. When 4:1 was exceeded in 2000 the ratio made it to nearly 4.8:1 by late 2001 and then reversed sharply. The ratio hit 4:1 again in 2004 and was catapulted to nearly 5.5:1 before it went into a nearly three-year bear market. The last time the ratio hit 4:1 was in 2009. It proceeded to climb for another two years and finally peaked at approximately 4.8:1 in 2011. It plummeted to a multi-year low from there.

Where Has This Coffee Spread ‘Bean’

Since the ratio between one 37,500 lb. Arabica coffee contract and one 10-tonne Robusta coffee contract closed at 3.76:1 on Friday lets round it up to 4:1 and create a spread between one Arabica coffee contract and four Robusta coffee contracts. This will help normalize the position to make it something that’s tradable.

The value of one Arabica coffee contract is approximately -$5k less than the value of the sum four Robusta coffee contracts. The spread between the March Arabica and Robusta (x4) contracts posted a contract high of -$2,703.75 on October 14th. This is pretty close to the ‘even money’ mark.

In the last quarter of a century, there have only been four occasions where the Arabica/Robusta (x4) coffee spread has reached ‘even money’ or higher. Each incident lasted a few months and three of those times it went to +$10k (premium Arabica) or higher. Ultimately, however, the spread reversed and dropped back down to -$30k or lower.

Based on this history, it seems doable that the spread could still run up several thousand dollars more from here. However, history also indicates that this will not last. A major decline should eventually take place. As a spread trader, one could have the best of both worlds by riding the blow-off phase of the coffee spread to higher ‘grounds’ and then flipping over to play the reversal.

Current Market Situation

Arabica coffee more than doubled in price this year as crops suffered when Brazil (the world’s largest Arabica coffee producer and exporter) experienced the worst drought in decades. The market dipped into July, but recovered to a new multi-year high this month on ideas that the supply is still tight.

In the meantime, Robusta coffee is lagging behind as Vietnam (the world’s largest Robusta coffee grower) is expected to reap a near-record harvest.

This divergence in the state of the two crops has caused the price disparity. This will be rectified at some point. History shows that a ratio of 4:1 or higher is ultimately unsustainable. Something has to give. The Arabica coffee will spill, Robusta coffee has to perk up, or there will be some combination of the two. A spread trading opportunity in the coffee market is brewing!

Trend Change Signals

There a couple of possible setups that could signal a bearish trend change for the Arabica/Robusta coffee (x4) spread:

First, a close below the rising weekly 30-bar Moving Average, basis the nearest-futures (somewhere around -$11,490 on Monday) for the first time in one-quarter of a year could signal a bearish trend change. The three-week break in late June/early July is the only time in 2014 that the Arabica/Robusta coffee (x4) spread has been below the rising weekly 30-bar MA.

Arabica Robusta Coffee spread weekly

Arabica Robusta Coffee spread weekly

Second, a break of the early September intermediate correction low of -$11,631.25 would alter the weekly price structure of higher highs and (mostly) higher lows.   A break of the early July major correction low of -$20,393.75 would confirm it.

Daily Chart: The Day of Reckoning Is Here

On the daily timeframe, the March Arabica coffee/Robusta coffee (x4) spread has reached a do-or-die level. The spread posted a contract high of -$2,835 (premium the sum of four Robusta contracts) on March 5th, it plunged to approximately -$17k by July, and then rallied for the last three months to marginally post a new contract high of -$2,703.75 on October 14th. The early March and mid-October highs are less than $1,000 away from the Fibonacci .618 retracement of the entire 2011-2013 collapse.

Follow-through to the upside could send the spread soaring toward the 2011 bull market high of +$18,810 (premium Arabica). Conversely, a drop from here could establish a double top on the charts. Either way, the spread could be in for a move of $15k or more from current levels.

March Arabica Robusta Coffee spread daily

March Arabica Robusta Coffee spread daily

At current levels, one strategy that a trader could use is a reversal system where a position is always in the market, long or short. The trick, of course, is to determine the price levels that will trigger buy signals and sell signals.

On the upside, a buy signal could be set at -$2k. This price is several hundred dollars above the potential double top between the early March and mid-October highs.   On the downside, a sell signal could be set at -$6k. This price is below the 20-day Moving Average and at a level that the spread has not seen in three weeks.

Trade Strategy:

For tracking purposes, the blog will hypothetically implement a reversal system for the March Arabica/Robusta coffee (x4) spread with a position consisting of one 37,500 lb. March Arabica coffee contract and four of the 10-tonne March Robusta coffee contracts. A long spread position (long Arabica and short Robusta) will be initiated on a close above -$2k and a short spread position (short Arabica and long Robusta) will be initiated on a close below -$6k. Each price level will act as a stop and reverse point. For example, if a long position is entered on a close above -$2k then a close below -$6k will trigger a signal to liquidate the long position and initiate a short position. If a short position is entered on a close below -$6k then a close above -$2k will trigger a signal to liquidate the short position and initiate a long position.

Hog/Corn Spread: Trade Signal Triggered

Lean Hog/Corn Spread

Yesterday the spread between the value of one April lean hog contract and one May corn contract closed at +$17,850. The close below the rising 30-day Moving Average for the first time since late August signaled a bearish trend change.   This triggered an entry signal on the short side.

The blog initiated a hypothetical trade to sell one 40,000 lb. April lean hog contract and simultaneously buy one 5,000 bushel May corn contract at +$17,850 (premium hogs). Initially, the exit strategy is to liquidate the spread on a close above +$20k (premium hogs). Furthermore, a close above +$20k (premium hogs) will also trigger a buy signal to initiate a long spread position. This is because the blog is using a reversal system that keeps us always in the market, long or short. Closings above +$20k trigger buy signals and closings below +$18k trigger sell signals.

April Hogs May Corn spread daily

April Hogs May Corn spread daily

A quick glance at the daily chart suggests that a double top is forming between the July 22nd high of +$19,395 and the slightly higher October 6th high of +$19,512.50. The lowest point between these two highs was the August 14th correction low at +$14,517.50. A break below this level will officially confirm the double top pattern.

Historically, the few times when the hog/corn spread reached +$15k or higher it eventually petered out and plunged to +$1k or lower. Although it is not a guarantee that this will happen again, it does give us a guideline for possible price target. This can come in handy when assessing the potential risk/reward on any trade setups that may allow a trader to add to the current short position. Let’s monitor the April-May hog/corn spread closely to see if any ‘add-on’ opportunities arise.

Corn/Oat Spread: Trade Signal Triggered

Corn/Oats Spread

Yesterday the spread between December corn and December oats closed at ‘even money’ where they finished above the declining 30-day Moving Average for the first time in five months. This triggered a bullish trend change.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

A hypothetical trade for the blog was triggered to buy one 5,000 bushel December corn contract and simultaneously sell one 5,000 bushel December oat contract at ‘even money’. Initially, the exit strategy is to liquidate the spread on a two-consecutive day close above -26 3/4 cents (premium oats).

At a minimum, we are looking for the spread to return to the one-dollar level (premium corn). If some low-risk setups occur along the way, we will discuss whether or not using them as opportunities to add to the long position in the December corn/oat spread would be a good idea.

Livestock Spread: Trade Parameters Revised

Feeders/Live Cattle Spread

On September 17th we had reentry parameters to short the Nov-Dec feeder/live cattle spread on a close below the August low. With several new contract highs since then and a new month starting a few days ago, the trade parameters can be revised.

We are going to move to a later delivery contract spread since the November feeder contract expires next month. Although it’s trading a dime cheaper than the soon-to-expire October contracts, the April 2015 feeder/live cattle spread is still at an historic extreme of 68.75. Also, the ratio of 1.42:1 is also at record levels.  Therefore, the April spread will be our new focus.

Trade Reentry Strategy:

The daily price data for the April feeder/live cattle spread only goes back five and a half months. However, there are currently no price breaks below a prior month’s low on the chart. This pattern is similar to the nearest-futures October spread that has not broken a prior month’s low since January. Therefore, we will use a break of the September low as a short sale signal this month. If it does not trigger by Halloween we will likely revise the trigger to a break of the October low.

April Feeders Live Cattle spread daily

April Feeders Live Cattle spread daily

The blog will make a hypothetical trade by shorting one 50,000 lb. April feeder cattle contract and simultaneously buying one 40,000 lb. April live cattle contract if the spread closes below last month’s low of 56.325. Initially, the spread will be liquidated on a two-consecutive day close .50 points above the contract high (currently 68.75) that precedes the trend change signal.

Cocoa/Sugar Spread: Trade Signal Triggered

Cocoa/Sugar Spread

Yesterday the spread between the value of one March cocoa futures contract and one March sugar futures contract closed at +$11,947.20 (premium cocoa). This put it below the rising weekly 10-day Moving Average for the first time in nearly five months, signaling a bearish trend change.

March Cocoa Sugar spread weekly

March Cocoa Sugar spread weekly

A hypothetical trade for the blog was triggered to sell one 10-ton March cocoa contract and buy one 112,000 lb. March sugar #11 contract at +$11,947.20 (premium cocoa). Initially, the exit strategy is to liquidate the spread on a two-consecutive day close above +$15,872.

Cattle Crush Spread: Trade Signal Triggered

Cattle Crush Spread

On September 17th a buy signal was triggered for the cattle crush spread (long six 40,000 lb. August 2015 live cattle contracts, shorting three 50,000 lb. April 2015 feeder contracts, and shorting two 5,000 bushel May 2015 corn contracts). Theoretically, the blog initiated a long position at -$8,000 (premium the sum of the feeders and corn).

On October 2nd the position would have been liquidated at a loss since the spread made a two-consecutive day close below -$12,500. The spread closed at -$19,425 so the theoretical loss on the trade would have been a whopping -$11,425 per spread.

Trade Reentry Strategy:

The break to new contract lows put the cattle crush spread below the nearest-futures 2011 and 2012 lows of -$17,597.50 and -$18,150.00, respectively. The 2012 is the lowest price in 45 years of price data. History shows that this inversion never lasts. So despite the recent collapse, we would be willing to get back in if price action warrants it.

August-April-May Cattle Crush spread daily

August-April-May Cattle Crush spread daily

The 2015 August-April-May 6:3:2 cattle crush spread has not closed above the declining 30-day Moving Average since mid-August. Therefore, a close back above the 30-day MA (around -$8,700 on Monday) would signal a possible bullish trend change.

The blog will make a hypothetical reentry trade by purchasing six 40,000 lb. August 2015 live cattle contracts and simultaneously shorting three 50,000 lb. April 2015 feeder contracts and shorting two 5,000 bushel May 2015 corn contracts if this 6:3:2 cattle crush spread closes above the 30-day MA. The position will be liquidated on a two-consecutive day close $500 below the contract low that precedes the entry price.