Live Cattle/Lean Hog Spread: An ‘Add-On’ Setup For a Short Sale

Live Cattle/Lean Hog Spread

The blog is currently holding a hypothetical short position in the December live cattle/lean hog spread entered at approximately 83.50 (premium cattle) on April 7th.

The live cattle/lean hog spread exploded to new record highs in Q4 of 2014. Even though it has backed off from the peak, it is still extremely overpriced. The December spread is currently around 82.00 (premium cattle). Historically, this spread was usually considered to be very expensive whenever it reached 35.00! Previous runs to this level were followed by a reversal that sent the live cattle/lean hog spread back below 20.00 (premium cattle). Therefore, it still has quite a low of downside potential.

Live Cattle Lean Hog spread monthly

Live Cattle Lean Hog spread monthly

The December live cattle/lean hog spread established a multi-month low of 74.35 on December 16th. After an explosive two-week rally, the spread backed off again and bottomed in February just above the December low. From there it launched a one-month run into new contract highs.

The Fibonacci .618 retracement of the entire move from the December 16th low to the March 23rd contract high offered support at 80.17. The December live cattle/lean hog spread neared this level in mid-April when it bottomed at 80.47 and bounced.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

Currently, the spread finds near-term support between the April correction low and the Fibonacci .618 retracement. A break below this level should confirm that the downtrend from the March peak is still in play. This would give traders a reason to initiate another short position. Risking to just beyond the current bounce off the April low provides a low-risk setup on the trade as well. And with price expected to eventually reach a significantly lower level, the reward-to-risk ratio is very attractive on this trade. It could be as high as 12:1! Therefore, aggressive spread traders could use this setup as an opportunity to add to short positions.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical ‘add-on’ trade by selling one 40,000 lb. December live cattle contract and simultaneously buying one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). If filled, risk a two-day close .50 points above the May high that precedes the entry.

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