Cattle Crush Spread: Exit Strategy Amendment

Cattle Crush Spread

The IMC blog is holding hypothetical long positions in the August-April-May 6:3:2 cattle crush spread. The initial position was entered at -$10,860 (premium the sum of the feeders and corn) On October 27th and an ‘add-on’ position was entered at -$350 (premium the sum of the feeders and corn) On February 23rd.

The first position was being risked to a two-consecutive day close below -$20,750 and the ‘add-on’ position was being risked to a two-consecutive day close below -$10k. But based on the current price action, we are going to amend the exit strategy.

Aug-April-May 2015 Cattle Crush spread daily

Aug-April-May 2015 Cattle Crush spread daily

The August-April-May 6:3:2 cattle crush spread did close below -$10k for two days, but we are going to give it a few more days of trade before exiting the ‘add-on’ position. The reasons for the change are four-fold:

First, the spread dropped for seven-consecutive days. This nearly matches the eight-consecutive day decline into the October 3rd low, which was followed by a complete recovery over the next several weeks.

Second, the seven-day decline knocked $14,362.50 off the August-April-May 6:3:2 cattle crush spread. This is remarkably similar to the $14,660 decline over the eight-day period into the October low, indicating that it may be very oversold here.

Third, in just over a month’s time the spread has retraced two-thirds of the four-month rally from the contract low to the February peak. Markets often reverse course after a retracement of either side of two-thirds of the preceding run. This phenomenon is exhibited by the adherence to the Fibonacci .618 (62%) retracement levels across many different asset classes on multiple timeframes.

Fourth, while this spread is in negative territory (the sum of the live cattle is discounted to the sum of the feeders and corn), the nearest-futures spread has the live cattle trading at a huge premium. This implies that the further out spread may be steeply underpriced.

Nearest-futures Cattle Crush spread monthly

Nearest-futures Cattle Crush spread monthly

While we have a set of trading and risk management criteria for the spreads, there are times when a market move requires some flexibility. This may just be one of those times, so we are going to keep a close eye on things for a few days and see how this plays out.

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