Feeder Cattle/Corn Spread
On November 19th the blog made a hypothetical trade entry on the short side of the April feeder/May corn (x6) spread when it rallied to +$1,000 (premium feeders). We’re risking this initial position to a two-consecutive day close above +$6,000 (premium feeders).
On December 9th the blog made a hypothetical ‘add-on’ trade entry on when the April feeder/May corn (x6) spread closed at a three-month low of -$7,512.50 (premium corn). This position is being risked to a two-consecutive day close above +$2,912.50 (premium feeders).
On December 26th the spread hit a five-month low of -$20,550 (premium corn). It then bounced as high as -$10,187.50 (premium corn) on January 2nd. This bounce gives us a potential setup to add to the short position. Spread traders can add another short position on a break below the December 26th low since it would keep the pattern of lower highs and lower lows intact. Furthermore, the initial position and the second ‘add-on’ position would be showing a healthy profit.
Before adding to the position, it is a good idea to assess the minimum expected risk/reward ratio on the trade on its own merit. If a short position is entered on a break below the December low of -$20,550 and risked above the current bounce high of -$10,187.50, the minimum risk on the trade wound be $10,362.50. Let’s call it $11k. We like to get a minimum risk/reward setup of 3:1 on any trade, so we would need to have a minimum profit expectation of approximately $33k to justify taking an ‘add-on’ with this criteria.
Historically, whenever the feeder/corn (x6) spread has surpassed -$10k (premium corn) on the upside it has ultimately reversed and gone back down to -$60k (premium corn) or lower. Most times, it has dropped to -$80k (premium corn) or lower. Therefore, a break below the December low should be followed by another $40-$60k of downside. With a ‘guess-timated’ risk of just under $11k on an additional ‘add-on’ trade and an expected profit $40-$60k if the minimum target is hit, the expected risk/reward ratio is greater than our minimum requirement of 3:1. This certainly meets our trade criteria.
For tracking purposes, the blog will make another hypothetical trade to sell one 50,000 lb. April feeder cattle contract and simultaneously buy six 5,000 bushel corn contracts if the spread closes below the December low of -$20,550 (premium corn). Initially, this position will be liquidated on a two-consecutive day close $500 above the highest closing price in 2015 that precedes the entry on this position (currently at -$10,187.50).