Hog/Corn Spread: Book The Profits

Lean Hog/Corn Spread Exit

On October 14th the IMC blog entered a hypothetical short position in the April-May hog/corn spread at approximately +$17,850 (premium hogs). We are currently using a two-day close above the declining 50-day Moving Average for the exit signal.

April Hog May Corn spread daily

April Hog May Corn spread daily

Tomorrow is the expiration day for the April hog contract, so we have to liquidate this side of the spread. The problem is that the July hog/corn spread surged above the 50-day MA today. Therefore, it may be prudent to take the money in the current position and run. We can then sit back and watch for a new setup in the July spread.

July Hog Corn spread daily

July Hog Corn spread daily

Lucky for us, the July hog/corn spread is trading at a premium of more than $6k to the April-May spread. Recall that the hog/corn spread has historically been a great short sale candidate when it reached +$15k or higher. The July spread rallied to a high of +$13k today, so the +$15k mark is within reach. The Fibonacci .618 retracement of the current decline from the contract high is located at +$15,771 and the current 2015 high is at +$15,947.50. A bounce into this area, followed by a reversal lower, could be an ideal setup to get back in the game. We will watch this one closely.

Trade Strategy:

For tracking purposes, the blog will liquidate the hypothetical short April-May hog/corn spread position at today’s close by buying back the short April hog contract and selling the long May corn contract.

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Arabica/Robusta Coffee Spread: Book The Profits

Arabica Coffee/Robusta Coffee Spread Exit

The blog entered a hypothetical short position in the Arabica coffee/Robusta coffee spread at on October 14th. The current position consists of one short 37,500 lb. May Arabica coffee contract and three long 10-tonne May Robusta coffee contracts entered at the equivalent of +$13,872.50 (premium Arabica).

On March 3rd the ratio between the value of one 37,500 lb. Arabica coffee contract and one 10-tonne Robusta coffee contract touched a thirteen-month low of 2.55:1. Historically, the ratio starts to look cheap once it slips below 2.25:1. Therefore, the odds of a continued decline in the spread are starting to diminish greatly.

From the early March low, the May Arabica coffee/Robusta coffee (x3) spread rallied nearly $10k. This was the largest rally in the last several months, indicating a trend change. Furthermore, the May spread surpassed a prior month’s high for the first time since October and altered the bearish price structure. It also made a two-day close above the declining 50-day Moving Average for the first time in five and a half months. This confirmed the bullish trend change.

May Arabica Robusta (x3) Coffee spread daily

May Arabica Robusta (x3) Coffee spread daily

This coffee spread has ‘bean’ a great trade, but the recent reversal indicates that it may be time to get out. The May Arabica coffee/Robusta coffee (x3) spread pulled back slightly from the April 6th bounce high, so we recommend using this opportunity to book the profits and complete a successful trade. Once you have closed out the position, go to your favorite coffee house and have a large pour over to celebrate! Be sure to tip your barista.

Trade Strategy:

For tracking purposes, the blog will liquidate the hypothetical short spread position at today’s close by buying back the short 37,500 lb. May Arabica coffee contract and selling the three 10-tonne May Robusta coffee contracts.

Gasoline/Crude Oil Spread: A Short Position Was Entered. Watch For ‘Add-On’ Opportunities!

RBOB Gasoline/Crude Oil Spread

On April 7th the blog made a hypothetical trade entry on the short side of the August RBOB gasoline/crude oil spread at $20.00 (premium gas). Initially, we are risking a two-consecutive day close above $22.00 (premium gas).

To determine the spread price, we first had to convert the price of gasoline from gallons to barrels. There are 42 gallons in one barrel. The RBOB gasoline futures contract controls 42,000 gallons of gas. Therefore, we multiply the price-per-gallon by 42 to calculate the price-per-barrel.

August RBOB gasoline closed at $1.8248-per-gallon yesterday. This converts to $76.64-per-barrel. August crude oil closed at $56.65-per-barrel yesterday. Therefore, gasoline closed at a premium of $19.99 over the crude oil.

Historically, spreads of $14 or more have normally been followed by declines back to $6 or less. Only the decline into the late December 2014 low missed this target when it bottomed at $6.93, basis the nearest-futures. Therefore, the initial entry at $20 with a trade risk of $2 and the minimum price objective of $6 yields a risk-to-reward ratio of 1:7 on the initial trade attempt. It gets better if some setups materialize for ‘add-on’ opportunities.

Gasoline Crude Oil spread monthly

Gasoline Crude Oil spread monthly

After posting a high of $23.58 in late February, the August RBOB gasoline/crude oil spread dropped $3.37 into the March low. It then bounced $1.68. Symmetrically, it would be ideal for the spread to match the initial decline and drop to somewhere around $18.50 before bouncing again. If a bounce of $1.50 or more follows, we may be able to use it as a setup to add to the short position. We will be watching the situation closely.

Gasoline/Crude Oil Spread: Did This Bull Market Just Run Out of Gas?!

RBOB Gasoline/Crude Oil Spread

The price action of RBOB gasoline and crude oil are highly correlated.  This makes perfect sense as gasoline is simply a derivative of the crude oil.  It’s quite rare for the two markets to move in different directions.  Looking at the last three decades of futures data drives this point home.  Plotting the closing prices of gasoline and crude oil for every month from the mid-1980s through now will reveal an extremely high correlation factor.

Gasoline Crude Oil overlay monthly

Gasoline Crude Oil overlay monthly

The ‘Crack’ Relationship

Even though they generally move in the same direction, the degree to which gasoline and crude oil move can vary.  Seasonal demand during driving season can push both of the markets higher, but gasoline may drive up at a faster rate.  The increase in user demand places a premium on the finished product.  Conversely, a build-up in the RBOB gasoline stocks can leave a glut of supply in the market place.  This could cause the price of gasoline to spill faster that the crude.

Historically, there have been extremes on both the high side where gasoline went up much faster than crude oil and the low side where the crude oil held up much better than gasoline.  It is when these extremes are hit that trading opportunities manifest.

The Gasoline/Crude Ratio

Over the last three decades, there have been less than a dozen occasions when the ratio between the closest-delivery month contract of RBOB gasoline was at 1.4:1 or higher against the closest-delivery month contract of crude oil.  A 40% mark-up on the gasoline doesn’t seem to last very long.

Gasoline Crude Oil ratio monthly

Gasoline Crude Oil ratio monthly

On a monthly closing-basis, the longest period that the RBOB gasoline/crude oil ratio was able to stay above 1.4:1 was three consecutive months. Whenever the ratio has made a month-end close above 1.4:1 and then finally turned over, it continued to plunge. Historically, the RBOB gasoline/crude oil ratio always dropped back down to a more reasonable level of 1.15:1 or lower. This indicates that the recent excursion north of 1.4:1 is a setup for trading opportunity on the short side of the spread.

Trend Change Signals

Last week, the nearest-futures RBOB gasoline/crude oil ratio finished the month of March at 1.56:1. This was the second month in a row that the ratio finished above 1.4:1. Therefore, a major reversal seems imminent.

August Gasoline Crude Oil ratio daily

August Gasoline Crude Oil ratio daily

Both the August RBOB gasoline/crude oil ratio and the spread made bearish trend change signals last week. The ratio made a two-day close below the rising 30-day Moving Average for the first time since November. The spread made a two-day close below the rising 30-day MA for the first time since late January. This indicates that the expected reversal is underway.

August Gasoline Crude Oil spread daily

August Gasoline Crude Oil spread daily

Unless we see a breakout to new highs, the RBOB gasoline/crude oil spread now has a clear path to return to a more ‘normal’ level of $10.00.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 42,000 gallon August RBOB gasoline contract and simultaneously buying one 1,000 barrel August crude oil contract at a spread of $20.00 or better. Initially, the spread will be liquidated on a two-consecutive day close above $22.00.