Feeders/Live Cattle Spread
This morning the October feeder/live cattle spread traded less than $200 away from the January 5th high, which marks the current high for 2015. The spread has now clipped slightly above the Fibonacci .618 retracement of the entire decline from the mid-November contract high to the late February contract low. This would be a good place for a secondary top to form. Therefore, we are going to get our parameters in place to get short if the spread does reverse from here.
If we’re really lucky, the spread will continue to run higher and try to return to the contract high of +$53,720 before it turns lower. This would give us an opportunity to get short at an even higher level after a double top or a Wash & Rinse (failed breakout) pattern occurs. But since we don’t know where the top is or when the reversal will happen, it makes sense to go ahead and have a plan in place.
The surge over the last two and a half years has taken the feeder/live cattle spread to record highs. History shows that this spread is normally priced at less than half of the current levels. The current ratio of 1.8:1 in the October contracts is just off the record high as well. By both measures, feeders are way too expensive in comparison to cattle. Over the last several decades, the ratio has always reversed and gone back down to 1.3:1 or lower after reaching 1.6:1 or higher. Therefore, the short side of the feeder/live cattle spread is where informed spread traders should be focusing their efforts.
The blog will work a hypothetical order to sell one 50,000 lb. October feeder cattle contract and simultaneously buy one 40,000 lb. October live cattle contract on a close below the May low of +$46,890 (premium feeders). Initially, the spread will be liquidated on a two-consecutive day close $500 above the watermark high of this rally that precedes the entry.