T-bond/T-note Spread: Roll To The June Contracts

T-bond/T-note Spread

In late January, the T-bond/T-note spread broke out to record highs as the cash yield on the 30-year bond sank to a record low. Both reversed shortly after and signaled a bearish trend change. We could have a tiger by the tail on this trade, so the IMC blog put out a trade strategy (hypothetical, of course!) to add to short positions if/when the spread accelerated to the downside.

T-bond_T-note spread weekly

T-bond_T-note spread weekly

The short T-bond/T-note spread is currently held in the March contracts. These have to be rolled over before Friday because of the First Notice Day. Typically, this is a simple procedure. But there’s a twist to the rollover this time. The June T-bond contract is trading at an eye-popping 15-full point premium over the March contract. There is a logical explanation for this: The June 2015 contract is the first futures contract that will reflect the period between 2001 and 2006 when the US government did not issue any 30-year bonds. This puts a premium on the price. The change in the contract specs will be reflected in the September and December contracts as well.

March T-bond_T-note spread daily

March T-bond_T-note spread daily

Due to the substantially increased premium on the June 30-year bond contract, the volatility of the June T-bond/T-note spread is noticeably higher and the June T-bond/T-note spread difference is approximately double that of the March T-bond/T-note spread. An equivalent short sale entry to the February 6th trend change signal with a risk to new highs would be approximately four and a half points compared to nearly two points. Therefore, traders should adjust for the difference in volatility by reducing the position size on the June spread to half of the March position size.

June T-bond_T-note spread daily

June T-bond_T-note spread daily

Another thing that needs to be changed is the size of the ‘interval ladder’ that we are using to enter/exit the spread. We were using intervals of two and one-quarter points (2-08) to trade the March spread. Since the volatility of the June spread is double, we will now use intervals of four and one-half points (4-16) to trade the June T-bond/T-note spread.

Trade Strategy:

For the short March T-bond/T-note spread at approximately 18-30 (premium T-bonds) on February 6th and the short ‘add-on’ March T-bond/T-note spread at approximately 16-20 (premium T-bonds) on February 20th, roll the short March T-bond contracts and the long March T-note contracts to the June contracts at the market-on-close on Wednesday, February 25th. Be sure to adjust for the difference in volatility by reducing the position size on the June spread to half of the March position size. Once the rollover to the June contracts has been made, risk both the June T-bond/T-note spreads to a two-day close above 36-07. Theoretically, this is the breakeven level for the initial short position. Therefore, you should size your June position so that a close at 36-07 would show a breakeven on the initial position and a loss on the ‘add-on’ June position that carries the same percentage risk size to your account as the ‘add-on’ March position initially did.

In addition, keep hypothetical orders working for two more ‘add-on’ positions in the June T-bond/T-note spread. The next ‘add-on’ will be triggered on a close at 27-27 or lower. The trailing stop will continue to work to liquidate all units on a two-consecutive day close four and one-half points (4-16) above the most recent entry price.

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Soy Meal/Bean Oil Spread: Roll To The May Contracts

Soy Meal/Bean Oil Spread

Friday is the First Notice Day for a slew of March futures contracts, including the grains. We certainly don’t want to take delivery of any of this stuff, so it’s best to swap out to some longer-dated contracts for our current spread positions.

Incidentally, those horror stories that you hear about somebody’s brother-in-law getting 50,000 bushels of corn dumped on their front lawn or a truck full of live cattle pulling into the driveway is a bunch of hogwash. If you forget to rollover and get put on delivery notice, you have ample time to retender. It’s going to cost you more commissions and some trade slippage, but your brokerage firm is going to make sure you get it done. As a matter of fact, it’s quite a process to take delivery of the contract even when you want to! I have been involved in taking delivery of futures contracts before and there are several steps involved. Bottom line: Always try to roll before First Notice Day, but don’t freak out if you are a day late. You can get it fixed.

May Soy Meal Bean Oil spread daily

May Soy Meal Bean Oil spread daily

Remember, the blog is currently using a reversal system to trade the soy meal/bean oil spread. The objective is to maintain a continuous spread position on either the long side or the short side. We are keeping the trade parameters in place to initiate a long position (long meal and short oil) on a close above +$17k and a short position (short meal and long oil) on a close below +$15k. Each price level will act as a stop and reverse point. For example, if a long position is entered on a close above +$17k then a close below +$15k will trigger a signal to liquidate the long position and initiate a short position. If a short position is entered on a close below +$15k then a close above +$17k will trigger a signal to liquidate the short position and initiate a long position.

Soy Meal Bean Oil spread monthly

Soy Meal Bean Oil spread monthly

The soy meal/bean oil spread initially caught our attention as a candidate on the short side. The value of a soy meal contract has only reached a premium of +$15k or more over the value of a bean oil contract a handful of times in the last five decades. It has always collapsed. However, with the May soy meal/bean oil spread currently around +$15k, an upside breakout could allow for a run of several thousand dollars if it returns to the double top on the monthly timeframe between the 1973 high of +$26,580 and last year’s record high of +$26,920. Therefore, we decided a reversal system could allow us to take advantage of either a historical outlier move to the upside or the bearish reversal that we ultimately expect to see.

Trade Strategy:

For the short March soy meal/bean oil spread entered at approximately at +$14,354 (premium meal) on November 19th, roll the one short 100-ton March soy meal contract and the one long 60,000 lb. March bean oil contract to the May contracts at the market-on-close on Wednesday, February 25th. Risk the short May soy meal/bean oil spread to a close above +$17k.

Also, keep the trade parameters in place to reverse and go long on a close above +$17k. If filled, continue to keep the trade parameters in place to reverse and go short on a close below +$15k.

Gold/Silver Spread: Roll To the Summer Contracts

Gold/Silver Spread

This Friday is the last trading day of February and the First Notice Day for the March silver futures contracts. Since our short April-March gold/silver (x7,000/oz.) spread is on the long side of the silver contracts, they need to be rolled over. Heck, as long as we’re doing a rollover let’s go ahead and roll our gold contracts, too. Then we don’t have to worry about rollovers in the metal contracts again until Memorial Day.

June-July Gold Silver (7,000 oz.) spread daily

June-July Gold Silver (7,000 oz.) spread daily

After surging to a multi-year high at the end of 2014, the gold/silver (x7,000/oz.) spread has become range-bound. Since early November the June-July gold/silver (x7,000/oz.) spread has basically been flip-flopping back and forth over the +$5k mark. It even formed a small double top between the December 16th high of +$8,922 and the December 31st high of +$8,906 . This sets near-term resistance. On the flip side, the January low of +$868 and the current February low of +$1,172 sets near-term price support.

We do not know which way the inevitable breakout will occur. A breakout to new highs could catapult the June-July gold/silver (x7,000/oz.) spread to the 2008 all-time high of +$13,519, while a clean break below the January/February lows could slam the spread to last summer’s low of -$17,500. What we do know is the history of this spread. Over the last few decades, the value of the 100 oz. April gold contract rarely keeps a premium over the value of 7,000/oz. of silver.

We also know that the last couple of times the gold/silver ratio has reached 75:1 or higher, it reversed and sank to 46:1 (in 2006) and 32:1 (in 2011). The bear markets after the reversals lasted three and a half years (from the 2003 top) and two and a half years (from the 2008 top).

Gold Silver ratio weekly

Gold Silver ratio weekly

With the nearest-futures gold/silver ratio has hitting a nearly four-year high of 75:1 back in November and the rally stalling out and with the gold market signaling a bullish trade change on the long-term charts at the end of last year, the time seemed right to start probing the short side of the gold/silver (x7,000/oz.) spread.

Trade Strategy:

For the short April-March gold/silver (x7,000/oz.) spread entered at the equivalent of approximately +$4,610 (premium gold) on January 14th, roll the one short 100 oz. April gold contract to the June contract and roll the one long 5,000 oz. March silver contract and two long 1,000/oz. March ‘mini’ silver futures contracts to the July contracts at the market-on-close on Wednesday, February 25th. Risk the short June-July gold/silver (x7,000/oz.) spread to a two-consecutive day close above +$9k.

Cattle Crush Spread: The ‘Add-On’ Buy Criteria Was Triggered

Cattle Crush Spread

Yesterday the blog entered a hypothetical ‘add-on’ trade on the long side of the August-April-May 6:3:2 cattle crush spread. The position was entered at -$350 (premium the sum of the feeders and corn) by purchasing six 40,000 lb. August 2015 live cattle contracts at 139.125 (total value of $333,900), selling three 50,000 lb. April 2015 feeder contracts at 197.05 (total value of $295,575), and selling two 5,000 bushel May 2015 corn contracts at $3.86 3/4 (total value of $38,675).

This new ‘add-on’ position will be will be liquidated on a two-consecutive day close below -$10k ((premium the sum of the feeders and corn).

Also, we are still working another ‘add-on’ trade to enter a third August-April-May 6:3:2 cattle crush spread on a close above +$6k (premium live cattle). This next ‘add-on’ position will be liquidated on a two-consecutive day close $500 below the lowest closing price that follows the February 6th peak. Once we get this one, our plates will be pretty full. We will have tripled the original position size at that point so we will become laser focused on managing risk and trying to squeeze as much profit out of the trade as possible.

The Cattle Crush Spread: The Stampede Continues! Time To Buy More.

The Cattle Crush Spread

On October 27th 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 the blog initiated a hypothetical long position.

The long position was entered at -$10,860 (premium the sum of the feeders and corn) by purchasing six 40,000 lb. August 2015 live cattle contracts at 153.60 (total value of $368,640), selling three 50,000 lb. April 2015 feeder contracts at 227.30 (total value of $340,950), and selling two 5,000 bushel May 2015 corn contracts at $3.85 1/2 (total value of $38,550).

The August-April-May 6:3:2 cattle crush has been trending higher since a multi-month low was established in early October. The live cattle finally traded at a premium over the feeders and corn in mid-January and a multi-month high of +$5,375 (premium cattle) was posted on February 6th.

Not Even Close

Technically, the trade we are doing here is a ‘reverse cattle crush’ where we are buying the end product (live cattle) and shorting the productions costs (feeders and corn). This is because the end product (live cattle) has been grossly underpriced by historic measures.

We looked at over four decades or price data to determine the parameters and discovered that the 6:3:2 cattle crush spread is usually nearing a bottom and providing a great buying opportunity when it trades under +$10k (premium live cattle). So even at this month’s new multi-month high of +$5,375 (premium cattle) the spread is still historically underpriced!

Aug-April-May Cattle Crush spread daily

Aug-April-May Cattle Crush spread daily

Remember that prior drops below the +$10k (premium live cattle) level have ultimately been followed by rallies back up in the +$20k to +$30k zone. We are nowhere in the neighborhood of this area yet. This indicates that the spread still has tremendous upside potential from here. To take advantage of it, aggressive spread traders could add to positions as the trade continues to accrue open profits.

Trade Strategy:

Thanks to the recent $5k pullback, we have two ‘add-on’ set ups for aggressive spread traders. For tracking purposes, the IMC blog will make the following two ‘add-on’ trades:

First, buy six 40,000 lb. August 2015 live cattle contracts and simultaneously short three 50,000 lb. April 2015 feeder contracts and short two 5,000 bushel May 2015 corn contracts at +$1k (premium live cattle) or better. This position will be liquidated on a two-consecutive day close below -$10k ((premium the sum of the feeders and corn).

Second, buy six 40,000 lb. August 2015 live cattle contracts and simultaneously short three 50,000 lb. April 2015 feeder contracts and short two 5,000 bushel May 2015 corn contracts on a close above +$6k (premium live cattle). This position will be liquidated on a two-consecutive day close $500 below the lowest closing price that follows the February 6th peak. In other words, we are risking a two-day break below the correction low that precedes a breakout to new contract highs.

T-bond/T-note Spread: The ‘Add-On’ Sell Signal Was Triggered

T-bond/T-note Spread

On February 6th the blog entered a hypothetical short position in the March T-bond/T-note spread at approximately 18-30 (premium T-bonds) when the spread made a two-day close below the rising 30-day Moving Average and signaled a bearish trend change.

We are running an ‘add-on’ strategy to increase the position size if/when the treasury spread continues to decline. The interval parameters for adding more spreads remain at two and one-quarter point declines from the most recent entry. Therefore, a hypothetical ‘add-on’ was initiated on Friday when the March T-bond/T-note spread closed at 16-20.

March T-bond T-note spread daily

March T-bond T-note spread daily

With the ‘add-on’ entered, the position size has been doubled. The liquidation for both the initial position and the new ‘add-on’ position will be moved to a two-consecutive day close above 18-30, which is a breakeven level for the initial spread.

We will keep hypothetical orders working for two more ‘add-on’ positions. The next ‘add-on’ will be triggered on a close at 14-12 or lower. The trailing stop will continue to work to liquidate all units on a two-consecutive day close 2-08 (two and one-quarter points) above the most recent entry price.

T-bond T-note spread weekly

T-bond T-note spread weekly

Yesterday the T-bond/T-note spread made an end-of-week close below the rising weekly 20-bar Moving Average for the first time since January 2014, triggering a bearish trend change on the larger timeframe. The last time this signal occurred, the T-bond/T-note spread sold off for an additional seven months and hit a two-year low. Things could get real interesting from here!

Arabica/Robusta Coffee Spread: Roll To the May Contracts

Arabica Coffee/Robusta Coffee Spread

The blog entered a hypothetical short position in the March Arabica coffee/Robusta coffee (x4) spread at -$6,447.50 (premium the sum of the Robusta contracts) on October 20th. Due to the approaching First Notice Day for March contracts, the position needs to be rolled to the May contracts.

The ratio between the value of one 37,500 lb. Arabica coffee contract and one 10-tonne Robusta coffee contract was near 4:1 back in October. Therefore, we traded four Robusta coffee contracts against one Arabica coffee contract to keep things equalized.

Arabica Robusta Coffee ratio daily

Arabica Robusta Coffee ratio daily

Today the Arabica/Robusta ratio dropped just below 3:1 for the first time in nearly thirteen months. Therefore, we would advise adjusting the spread position to trade three Robusta coffee contracts against one Arabica coffee contract to keep a balanced weighting on the spread.

Trade Strategy:

For tracking purposes, the blog will liquidate the short position in the March Arabica coffee/Robusta coffee (x4) spread and simultaneously initiate a short position in the May Arabica coffee/Robusta coffee (x3) spread at the market-on-close on Tuesday, February 17th. (Notice the May spread will have three Robusta contracts instead of four). Risk the May spread to a two-consecutive day close above +$8,800.

Cocoa/Sugar Spread: Setup For Another ‘Add-On’ Entry

Cocoa/Sugar Spread

Since surpassing the +$15k (premium cocoa) level last fall, we have been of the opinion that the cocoa/sugar spread will ultimately roll over and return to the ‘even money’ level. This is because the last few decades of price history implies that this spread is historically ‘expensive’ whenever it reaches +$10k or higher. And on those infrequent occasions when it has made it to the +$15k mark higher (this has only happened six times in the last forty years) it eventually reversed and dropped all the way back below the ‘even money’ mark.

Cocoa Sugar spread monthly

Cocoa Sugar spread monthly

The blog initiated a hypothetical short position in the May cocoa/sugar spread at the equivalent of +$12,098 (this was initially a March spread and then rolled to the May contracts yesterday) on October 3rd. The recent price action has provided another potential short sale setup. Therefore, a trader could use it to add to the current short position.

On November 14th the May cocoa/sugar spread touched a four-month low of +$9,763.60 (premium cocoa). It rallied from there and made a Fibonacci .618 retracement of the decline from the September multi-year top. The spread then rolled over and nearly returned to the November low when it closed +$9,848.40 on January 26th. It has since rallied to roughly $300 away from the January bounce high.

May Cocoa Sugar spread daily

May Cocoa Sugar spread daily

The similar November and January lows create a double bottom support level for the May cocoa/sugar spread. A potential trade off this pattern would be to go short on a break below the double bottom and risk above the bounce high (the highest high between these two lows). Currently, the risk on a trade with these parameters would be somewhere around $3k to $3,500. It’s hard to be exact, though, because you don’t know how far beyond the highs and lows the close will be to trigger the entry and exit signal.

With a minimum objective of ‘even money’ and a ‘guesstimate’ risk of a little more than $3k, the approximate reward-to-risk ratio on such a trade would be somewhere around 3:1. Given the fact that the initial short position would show a decent open profit by the time this second trade would get elected, it seems that this would be an acceptable ‘add-on’ trade for the May cocoa/sugar spread. Therefore, aggressive spread traders could use this to take advantage of the bearish trend that is unfolding.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical ‘add-on’ trade by selling one 10-ton May cocoa contract and simultaneously buying one 112,000 lb. May sugar #11 contract if the spread closes below +$9,700. If filled, risk a two-day close above +$13k. The exit level is above the January 12th high of +$12,885.20, which is the highest closing price between the November and January lows.

Cocoa/Sugar Spread: Roll To the May Contracts

Cocoa/Sugar Spread

The blog entered a hypothetical short position in the March cocoa/sugar spread at +$11,947.20 (premium cocoa) on October 3rd. Since we’re short…and the cocoa/sugar combo is sweet…let’s make this commentary short and sweet as well: The liquidity has shifted over to the May contracts, so we’re inclined to roll to the May contracts.

May Cocoa Sugar spread daily

May Cocoa Sugar spread daily

Trade Strategy:

For tracking purposes, the blog will roll the March cocoa/sugar spread to the May cocoa/sugar spread at the market-on-close on Wednesday, February 11th. Risk the May spread to a two-consecutive day close above +$15,872.

T-bond/T-note Spread: The Entry Signal Was Triggered For a Short Sale

T-bond/T-note Spread

On February 6th the March T-bond/T-note spread made a two-day close below the rising 30-day Moving Average for the first time since late September. This signaled a bearish trend change on the daily timeframe and triggered a short sale signal.

The IMC blog made a hypothetical trade by selling a March T-bond contract at approximately 147-21 and simultaneously buying a March T-note contract at approximately 128-23. This puts us in a short spread position at approximately 18-30 (premium T-bonds). We will initially liquidate the spread on a two-consecutive day close above 20-31, which is 8/32nds (one-quarter point) above the January 28th contract high at 20-23.

T-bond T-note spread daily

T-bond T-note spread daily

In addition, the ‘add-on’ strategy to short more spreads on the way down still stands. We are using intervals of two and one-quarter points, so the next ‘add-on’ will be triggered on a close at 16-22 or lower. We will keep the hypothetical orders working to short the March T-bond/T-note spread (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.

Friday’s better-than-expected jobs report may have been the straw that breaks the camel’s back. The average job gains over the last three months was the strongest since 1997 and average hourly earnings made the biggest jump since November of 2008. This revived speculation that the Fed will begin raising interest rates this year after all.

If the T-bond/T-note spread can make an end-of-week close below the rising weekly 20-bar Moving Average (currently around 17-00) for the first time since January 2014 it will confirm the bearish trend change from the daily timeframe and potentially usher in a multi-month decline.