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!
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.
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.