T-bond/T-note Spread: Trade Parameters Revised

The T-bond/T-note Spread Interval Ladder

Since October we have had a hypothetical order working to short the T-bond/T-note spread with parameters for increasing the position with an ‘interval ladder’ if it starts a down trend. With the continued price surge, we have room to bump up the entry parameters a bit higher.

Last week made history as the nearest-futures December T-bond/T-note spread rocketed to a new all-time high of 19-03.5. The March spread is not too far behind as it also posted a new contract high of 18-04.5 on December 16th.

March T-bond T-note spread daily

March T-bond T-note spread daily

On the daily timeframe, near-term technical support is located between the rising 30-day Moving Average around 15-24 (the March T-bond/T-note spread has not made a two-day close below the 30-day MA since September) and the November high of 15-18.5. (Old price resistance, once it has been broken, becomes new price support). A two-day close below the 30-day MA and a break back under the November high would signal a bearish trend change.

T-bond T-note spread weekly

T-bond T-note spread weekly

On the weekly timeframe, the T-bond/T-note spread finds technical support at the rising 20-bar Moving Average around 15-04. An end-of-week close below the weekly 20-bar MA for the first time in nearly a year would signal a bearish trend change. This could finally kick off a multi-month decline in the T-bond/T-note spread.

Since the T-bond/T-note spread usually follows the path of the 30-year Treasury bond, it is important to note the recent potentially bearish developments in T-bonds. First of all, the nearest-futures T-bonds traded as high as 147-30 on December 16th, which is just two ticks shy of the October 15 spike high at 148-00. The market then dropped sharply for a couple of days afterwards. This could be the makings of a double top formation on the charts. It was confirmed today when the market altered the bullish price structure by making a break below a previous week’s low for the first time since the November 7th correction low was established. This is an ominous sign for US Treasuries.

T-bonds (nearest-futures) daily

T-bonds (nearest-futures) daily

Secondly, consider the fact that T-bonds are currently poised for a fourth place tie with 2011 for the biggest annual gains since the Great Depression era. Looking at the ten best annual performances in this time period, eight of them were followed by a loss the next year. The two years that managed to extract more gains from T-bonds were 1986 with a gain of approximately 13 full points and 2012 with a gain of approximately two and three-quarter points. Therefore, probabilities are against another gain for T-bonds in 2015 and the odds of a sizable gain are even less favorable. This implies that the T-bond/T-note spread is headed for a decline in 2015.

Trade Strategy:

Cancel the hypothetical order to sell a March T-bond/T-note spread on a close below 13-24 (premium T-bonds) and replace it with a new hypothetical order to sell one March T-bond/T-note spread on a two-day close below the rising 30-day Moving Average (currently around 15-24) or an end-of-week close below the rising weekly 20-bar Moving Average (currently around 15-04), basis the nearest-futures. If filled, the position will be liquidated on a two-consecutive day close 8/32nds (one-quarter point) above the contract high that precedes the entry (currently at 18-04.5). In addition, continue to short more March T-bond/T-note spreads (single contracts) on each close that is 2-08 lower than the prior entry price until a total of four units (the initial entry position 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.

Advertisements

Gold/Silver Spread: Exit And Reentry Setup

Gold/Silver Spread

On November 25th The IMC blog initiated a hypothetical trade by selling one 100 oz. February gold contract at approximately $1,197.80 (a value of $119,780) and simultaneously buying one 5,000 oz. March silver contract and two 1,000/oz. March ‘mini’ silver futures contracts at approximately $16.61 (a total value of $116,270). This established a short spread position at approximately +$3,510 (premium gold).

The exit strategy was to liquidate on a two-consecutive day close above +$7,200. The exit was triggered on December 17th when the spread closed at +$7,954. This represented a hypothetical loss of -$4,444 on the position.

Last week’s weakness in the precious metals allowed the February-March 100-ounce gold/7,000-ounce silver spread to push briefly beyond the November 28th top. Unless a reversal materializes, the spread currently has no price resistance at this point until the 2008 all-time high of +$13,519.

February Gold March Silver (7,000 oz.) spread daily

February Gold March Silver (7,000 oz.) spread daily

On December 9th the February-March gold/silver (x7,000/oz.) spread broke a prior month’s low for the first time since July and altered the bearish price structure. It also closed below the rising 50-day Moving Average for the first time since the start of August. This indicated that the trend has turned bearish. Last week’s breakout to new highs negated the trend change signal. However, a close below the December 10th multi-week correction low of +$2,631 should get the spread back on track with the bear trend. This would be reason to get right back in on the short side.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 100 oz. February gold contract and simultaneously buying one 5,000 oz. March silver contract and two 1,000/oz. March ‘mini’ silver futures contracts if the spread makes a two-day close below the rising 50-day MA (currently around +$4,550) or a one-day close below the December 10th low of +$2,631, whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry signal (currently at +$9,166).

Live Cattle/Lean Hog Spread: Entry Signal Triggered

Live Cattle/Lean Hog Spread

Today the February live cattle/lean hog spread closed at 75.35 (premium cattle). This put it back below both the 50-day Moving Average and the December 8th low, confirming the bearish trend change from last week. Today’s price break triggered a short sale signal.

February Live Cattle Lean Hog spread daily

February Live Cattle Lean Hog spread daily

The IMC blog made a hypothetical trade by selling one 40,000 lb. February live cattle contract at approximately 155.82 and simultaneously buying one 40,000 lb. February lean hog contract at approximately 80.47. This opens a short spread position at 75.35. Initially, we will liquidate the spread on a two-consecutive day close above 82.42.

Feeder Cattle/Live Cattle Spread: Short Sale Entry Signal Triggered

Feeders/Live Cattle Spread

On December 12th the April feeder/live cattle spread closed broke the October low and closed at 59.70. This signaled a bearish trend change and triggered a short sale signal.

April Feeders Live Cattle spread daily

April Feeders Live Cattle spread daily

The IMC blog made a hypothetical trade by selling one 50,000 lb. April feeder cattle contract at approximately 221.10 and simultaneously buying one 40,000 lb. April live cattle contract at approximately 161.40. This puts us in a short spread position at approximately 59.70 (premium feeders). Initially, we will liquidate the spread on a two-consecutive day close above 69.25.

History indicates that feeders normally have a premium of 10 to 15 cents over the live cattle. If so, ‘normal’ is a long, long way down from here. If the new bear market takes hold the feeder/live cattle spread should be in for a substantial decline. We will be monitoring the price action to see if there is any opportunity to add to the short position.

Live Cattle/Lean Hog Spread: Is This Bull Run About To “Meat” It’s End?!

Live Cattle/Lean Hog Spread

Despite the variation in fundamentals and the differences in the breeding cycles, the historical price trends between live cattle and hog prices are noticeably correlated. In broad strokes, this is likely due to similar feed costs, weather impact, and consumer demand.

Live Cattle Lean Hog overlay monthly

Live Cattle Lean Hog overlay monthly

With nearly half a century of price data showing the strong link between these two markets, we have assurance that the link is strong enough to trade one market against the other. You will notice that the hog prices seem to be a little more ‘spikey’ and that the cattle prices trend in a smoother manner. This is because the hog market has a shorter breeding cycle. Nonetheless, the hog market’s aberrations have proven to be temporary as it has always come back into synch with the cattle market.

Historical Spread Parameters

Live cattle usually trade at a premium over hogs. Either side of a 20-cent premium seems to be a somewhat normal level for the spread between the two markets.

Once in a while, we see brief occasions where the spread between live cattle and lean hogs widen to 35 cents or more. These are the times that spread traders need to sit up and take notice because an opportunity could be forming. Historically, premiums of 35 cents or more have been temporary events as the spread has inevitably returned to the 20-cents level.

Live Cattle Lean Hog spread monthly

Live Cattle Lean Hog spread monthly

After the historic drought of 2012 wreaked havoc in the grain and livestock markets, the live cattle/lean hog spread has gyrated all over the place. This year, it has surged to an all-time high. If history is any guide, this could be a nice short sale opportunity in the making.

Historical Ratio Parameters

With livestock prices at record highs, it is no surprise that the livestock spreads are also priced at historical levels. Therefore, it is prudent to take into account the ratio when trying to determine if a relationship between two different livestock markets are actually at an extreme. The ratio acts as a filter for the spread.

Forty-five years of history shows that the ratio between cattle and hogs has been volatile, but lacking in long-term trendiness or a change in the overall trajectory. For spread traders who are banking on a mean reversion, this is the perfect scenario.

Live Cattle Lean Hog ratio monthly

Live Cattle Lean Hog ratio monthly

Overall, it appears that the live cattle/lean hog ratio flip-flops violently over the 1.4:1 level. When the ratio drops below 1.1:1 (where cattle has a premium of less than 10% over the hogs) the cows are considered under-priced. This has been the right time to look for setups on the long side of the spread and go long cattle and short hogs.

On the flip side, a ratio of 1.8:1 or higher (where cattle has a premium 80% or greater over the hogs) has been historically unsustainable. These occurrences are where the prime short sale opportunities have occurred. Spreads traders empowered with the knowledge of history could have taken advantage of the situation by shorting the cattle and buying hogs. Ratios of 1.8:1 or higher have always been followed by substantial declines.

This year’s breakout to new all-time highs in the live cattle/lean hog spread has been confirmed by the ratio. The cattle/hog ratio joined an elite group this year as it reached 1.9:1 so far. The ratio has been this high on less than a dozen occasions in the last half century. Therefore, we should be looking for a trade setup on the short side of the spread.

Trend Change Signals

Based on the price action of the last week, there were two signals that indicated a possible bearish trend change in the February live cattle/lean hog spread:

February Live Cattle Lean Hog spread daily

February Live Cattle Lean Hog spread daily

First, the February live cattle/lean hog spread started the week with a break below a prior month’s low for the first time since the mid-July correction low was established. This altered the price structure. Furthermore, it occurred just a week after a new contract high was posted. This creates an ‘outside bar’ on the monthly bar charts since the spread has traded beyond both the previous month’s high and low.

Second, the February live cattle/lean hog spread closed below the rising 50-day Moving Average on December 8th for the first time since mid-July.

There is one thing that should make traders give pause: The ratio between the February live cattle and the February lean hog actually ended the week at a new contract high of 1.95:1! However, the February lean hog contract peaked out in July and sank to a new multi-month low on Friday while the February live cattle contract signaled a bearish trend change this week by way of a close below the rising 50-day Moving Average for the first time since August and a break below the prior two month’s lows for the first time this year.

February Live Cattle Lean Hog ratio daily

February Live Cattle Lean Hog ratio daily

The February live cattle/lean hog spread bounced off the December 8th nearly two-month low of 76.75 (premium cattle) and finished the week above the 50-day MA. Therefore, traders looking to short this spread might want to wait for a drop back under the December 8th low to increase the probabilities that the tide has finally turned.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 40,000 lb. February live cattle contract and simultaneously buying one 40,000 lb. February lean hog contract if the spread closes below the December 8th low of 76.75. Initially, the spread will be liquidated on a two-consecutive day close of half a cent (50 pts.) above the contract high that precedes the entry (currently at 81.92).

 

Feeder Cattle/Corn Spread: ‘Add-On’ Entry Signal Triggered

Feeder Cattle/Corn Spread

Today the April feeder/May corn (x6) spread closed at a three-month low of -$7,512.50 (premium corn). The break below -$7k elected our ‘add-on’ short sale criteria. Therefore, IMC blog made a hypothetical trade by selling one more 50,000 lb. April feeder cattle contract at approximately 227.225 (contract value of $113,612.50) and simultaneously buying six more 5,000 bushel corn contracts at approximately $4.03 3/4 (total value of $121,125). Initially, we will risk this ‘add on’ position to a two-consecutive day close above +$2,912.50 (premium feeders), which is $500 above the November 19th rally high.

April Feeders May Corn (x6) spread daily

April Feeders May Corn (x6) spread daily

Based on four decades of price history, it is not unreasonable to expect the feeder/corn (x6) spread to return to the -$60k (premium corn) level. The spread has not been this low since spring. There’s still a lot of ground to cover for it to get there, which also means there is ample opportunity for new short sale setups to materialize. This could allow spread traders to continue pyramiding a short position in order to take full advantage of the move. We will continue to monitor the situation and see if the hoped-for setups show up.

Livestock Spread: Trade Parameters Revised

Feeders/Live Cattle Spread

Previously, we were working a hypothetical order to short the April feeder/live cattle spread on a break below the September low. We started a new month this week. The spread has not yet breached support at a prior month’s low since the data for this spread started in April of 2014. Therefore, we can go ahead and raise the short sale level on this trade.

April Feeders Live Cattle Spread daily

April Feeders Live Cattle Spread daily

Last month was a quiet one for the April feeder/live cattle spread. It did not trade above the prior month’s high or the prior month’s low. Currently, the spread is testing last month’s high. If it breaks through, the October 3rd contract high of 68.75 could soon be matched.

Our main focus, however, is the price support for the uptrend. The October low of 59.95 and the November low of 61.15 set a support zone for the April feeder/live cattle spread that, if breached, could end the bull market and start a major decline. Therefore, we are going to bump our entry parameters up to just below this support zone.

April Feeders Live Cattle Ratio daily

April Feeders Live Cattle Ratio daily

The April feeder/live cattle ratio looks pretty enticing on the charts as well. The October and November lows were both at 1.36:1 and the ratio has already surpassed the November high. This confirms a double bottom low at the October and November lows. If the ratio cracks 1.36:1 it will signal a failure of the bullish pattern. We’ll take this kind of pattern failure as a short sale signal any time!

Trade Reentry Strategy:

The IMC 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 the October 30th low of 59.95. 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.