Feeder Cattle/Corn Spread
The blog is working an order to short the August-September feeder/corn (x6) spread on a break of the May low. Recent price action gives us room to bump the entry level a bit higher. In addition, we are going to buy ourselves a little more time and switch from the August feeder contract to the October contract.
The mid-November bounce high of -$2,175 (premium corn) was a resistance level to watch in the October-September feeder/corn (x6) spread. This level was clipped on May 11th when the spread closed at -$1,725 and started to roll over. It looked like we had the potential for a double top up here.
A week and a half later, the spread blew past the May 11th top and didn’t pause until it reached +$3,100 (premium feeders) on June 1st. Therefore, the November 19th and May 11th highs turned into a price support level.
The October-September feeder/corn (x6) spread then retreated from the June 1st high, bottoming out at -$1,975 on June 8th. This was right at the price support zone between the November 19th and May 11th highs of -$2,175 and -$1,725, respectively. From there, the spread recovered quickly. It is now right back on the doorstep of the June 1st high.
So now we have a line of defense at the November 19th high of -$2,175, the May 11th high of -$1,725, and the June 8th pullback low of -$1,975. A breach of this support could indicate that the run is over. Therefore, we have good reason to bump the entry price up to a break below this support zone.
In terms of the ratio between the value of one 50,000 lb. October feeder cattle contract and one 5,000 bushel September corn contract, the November 19th high was 5.89:1, the May 11th high was 5.91:1, and the June 8th pullback low was 5.89:1. At nearly six-to-one, this is why we are spreading six corn contracts against on feeder contract. It helps to normalize the position.
In the last four decades, only 2005, 2014, and this year saw the nearest-futures feeder/corn ratio hit 6:1 or higher. Historically, the ratio does not go above 4:1 or below 2:1 very often. Whenever that has happened, the ratio has eventually reversed and gone back to either side of 3:1. Therefore, we can say that the current ratio is about double what it should be. A break of Monday’s pullback low in the spread and the ratio could potentially be the crack that’s needed to break the whole dam open.
Cancel the hypothetical order to short the August-September feeder/corn (x6) spread on a break of the May low. We will work a new hypothetical order to sell one 50,000 lb. October feeder cattle contract and simultaneously buy six 5,000 bushel September corn contracts if the spread closes below -$2,200 (premium corn). Initially, the spread will be liquidated on a two-consecutive day close $500 above the multi-month rally high that precedes the entry (currently at +$3,100).