Soy Meal/Bean Oil Spread: Exit May Spread And Set Parameters For The December Spread

Soy Meal/Bean Oil Spread

Back in November, the IMC blog decided that a reversal system might be a good way to capture a move in the soy meal/bean oil spread. On the one hand, both the spread and the ratio between these two soy products reached extremes that have only been seen a dozen times or less in the last half century. Historically, this made it a great trade candidate on the short side.

On the other hand, the March soy meal/bean oil spread was sitting less than $1,000 away from its contract high. A breakout to new contract highs could have cleared the path for the spread to return to the prior nearest-futures top, which was another $10k higher. Therefore, we figured that a breakout on either side could lead to a move of several thousand dollars.

The reversal parameters were simple: Buy the soy meal/bean oil spread on a close above +$17k and sell the spread on a close above +$15k. Reverse positions anytime the alternate price level is triggered.

Where We Are, Where We’re Going

Currently, the blog is holding a hypothetical short position in the May soy meal/bean oil spread entered at the equivalent of +$13,164 (premium meal) on November 19th. This is noticeably below the $15k threshold that would have triggered the short sale. The reason for this is because of the backwardation where the further out spreads are trading at a discount to the closer delivery spreads. This has caused our equivalent entry price to drift.

May Soy Meal Bean Oil spread daily

May Soy Meal Bean Oil spread daily

The First Notice Day for the May grain contracts is on Thursday, so we need to roll the spread position. Instead of doing a straight rollover, we are going to change things up just a bit.

December Soy Meal Bean Oil ratio daily

December Soy Meal Bean Oil ratio daily

With the exception of the mid-September/early October plunge, the soy meal/bean oil spread has really been stuck in a wide trading range for the last eleven months. The new crop December spread set a contract high of +$14,854 on November 14th and the lowest it has been since then was +$11,596. For the last several months, the ratio has been flip-flopping back and forth over 1.7:1 and the spread has been flip-flopping back and forth over +$13k. In the past, whenever the nearest-futures ratio reached 2:1 or higher and reversed, it eventually declined to 1:1. Therefore, the December spread still has plenty of downside potential.

Soy Meal Bean Oil ratio monthly

Soy Meal Bean Oil ratio monthly

So here’s what we are going to do: Let’s liquidate the May soy meal/bean oil spread and call it a day. We will then set up new reversal system parameters for the new crop December spread. Since the December spread is trading at a lower price than the spring contracts, the $17k and $15k reversal levels are not ideal. Therefore, we will adjust the parameters to +$15,500 for the buy point and +$13,500 for the sell point. This puts the buy point several hundred dollars above the current contract high and the sell point at a price that the spread has had no trouble reaching over the last year.

December Soy Meal Bean Oil spread daily

December Soy Meal Bean Oil spread daily

The spread is quite a bit below the sell level right now, so we will have to wait for a rally to initiate the short position and get the reversal system activated again.

Trade Strategy:

For the short May soy meal/bean oil spread at the equivalent of +$13,164 (premium meal) on November 19th, exit right here at +$12,824 or better.

Also, implement a reversal system for the December soy meal/bean oil spread. Sell one 100-ton December soy meal soy meal contract and simultaneously buy one 60,000 lb. December bean oil contract if the spread rallies to +$13,500 (premium meal). Exit the short position and reverse to a long position on a close above +$15,500 (premium meal) and keep the reversal system parameters in place to reverse and go short again on a close back below +$13,500.

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