Kansas City/Chicago Wheat Spread: Roll to May Contracts

Patience Is a Virtue

Historically, Kansas City wheat usually trades at a good premium over Chicago wheat. There’s no mystery to it: KC wheat is a better grade than the CBOT wheat. Therefore, it should be reflected in the price.

Once in a while, though, the KC wheat will get priced at a discount to CBOT wheat. It has always been a buying opportunity, so we watch for it.

The spread inverted last year. So we started looking for a place to buy. And on November 30th, the blog bought the KC/Chicago wheat spread at -2 3/4 cents (premium CBOT wheat).

Here we are nearly three months later, and the spread is priced only a couple of pennies different from where we got in! Granted, that’s still better than where it was priced just a couple of weeks ago.

But you’d think that, after a nearly eight months of a discounted price on the nearest-futures spread, that it would be well on its way back to normal by now. Based on history, we’re looking for the KC wheat to reach a premium of 35 to 40 cents or more over the Chicago wheat.

Hasn’t happened yet. Nonetheless, we soldier on.

Pass the Wheat Rolls, Please

Monday is First Notice Day for the March grain contracts. That means we need to get out of the March contracts by tomorrow…or risk getting delivery notices on the long contracts. That’s not my idea of fun. The thought of getting 5,000 bushels of wheat for every long contract I have makes me very gluten intolerant!

May KC wheat CBOT wheat spread daily (200-day MA)

May KC wheat CBOT wheat spread daily (200-day MA)

We are going to stay the course with the long position in the KC/Chicago wheat spread, but we need to rollover and buy some more time. Therefore, we’ll liquidate the March contracts and immediately get into the May spread.

Trade Strategy:

At today’s market-on-close, sell the long March Kansas City wheat contract and simultaneously buy one May Kansas City wheat contract. Also, buy back the short March Chicago wheat contract and simultaneously sell one May Chicago wheat contract. This will liquidate the March spread and open a long position in the May spread.

Risk the May KC/Chicago wheat spread to a two-day close below -20 cents (premium CBOT wheat).

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US Treasury Spreads: The End of the Ride

Good Place For a Top

We live in a world of low or no yield in Treasuries. Many interest rates are even in negative territory! Nonetheless, when Treasuries or Treasury spreads reach prior tops or change their currently bullish price patterns, it could be worth taking an uber-contrarian position and going short.

I can’t count the amount of times that we’ve entered a spread long before it made any fundamental sense and then went on to make a huge profit. It seems that the fundamentals played catch-up weeks after we got in. By that time, the train had left the station and a big chunk of the move was already over.

The T-bond/T-note Spread

On the daily nearest-futures chart, the T-bond/T-note spread peaked at a high of 36-14 (premium T-bonds) last year…on April Fools’ Day! The top was established just a couple of weeks after the March 2015 contracts expired.

It is important to know what took place after the March 2015 contracts expired, because the June 2015 contracts were price at a significant 15-full point premium over the March contract. This was due to a change in the contract specs. The June 2015 contract is the first futures contract that reflects the period between 2001 and 2006 when the US government did not issue any 30-year bonds. Ergo, the huge price premium. So the mid-March surge was not nearly as spectacular as it looks.

T-bond T-note spread daily (nearest-futures)

T-bond T-note spread daily (nearest-futures)

Nonetheless, after the April price peak was established, the T-bond/T-note spread dropped nearly fourteen full points by the end of June.

Fast-forward to today. The global stock market sell off and ideas that the Fed will have to stop or even reverse their tightening monetary policy has propelled Treasuries higher for the last several weeks. So a week and a half ago, the spread traded to 36-10…just one-eighth of a point away from the 2015 April Fool’s top.

The T-bond/T-note spread then made a pullback into the middle of last week, followed by a rebound that erased two-thirds of the pullback. Is this a double top in the making? Maybe. The nice thing is that the pullback and initial rebound provides a great trade setup on the short side.

A break below the February 17th pullback low would mean that the T-bond/T-note spread has made a lower low after the bounce into (hopefully) a lower high. The resulting bearish price structure could mark the beginnings of a downtrend. It’s even more damning for the spread to have it happen after nearly tagging last year’s high. Therefore, traders would have a green light to get short.

The T-note/5-Year-note Spread

Moving closer in on the yield curve, the nearest-futures T-note/5-Year note spread soared to a three and a half year high of 10-07 (premium T-notes) on February 11th. It surpassed last year’s top and traded less than a point away from the 2012 all-time high. The T-note/5-Year note spread also pulled back in a February 17th low, but the bounce that followed was more muted.

The 2015 high in the T-note/5-Year note spread was 9-18.25. After surpassing it earlier this month, the nearest-futures spread pulled back below this old high and closed one-eighth of a point below it at 9-14. The spread is now back above the 2015 high. This puts it in a fluid situation:

T-note 5-year note spread daily (nearest-futures)

T-note 5-year note spread daily (nearest-futures)

A continued recovery that sends the T-note/5-Year note spread past the current high of 10-07.25 would be very bullish. It would indicate that the initial pullback and test of support worked.

Conversely, a break below the February 17th low would confirm that a Wash & Rinse sell signal has been triggered.

The Bottom Line

The run in the US Treasury spreads were followed by a brief pullback and then a bounce from last week’s correction lows. A break below last week’s correction lows could indicate that the run is over. If so, short positions would be the way to play it.

*Trade Strategy:

T-bond/T-note Spread

The blog will make a hypothetical trade by shorting one June T-bond contract and simultaneously buying one June T-note contract if the spread closes below 33-05 (premium T-bonds). Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the contract high (currently at 35-11).

T-note/5-Year-note Spread

The blog will make a hypothetical trade by shorting one June T-note contract and simultaneously buying one June 5-year note contract if the spread closes below 9-06 (premium T-notes). Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the contract high (currently at 9-30).

*Being in both spreads would be the equivalent of being short one 30-year bond and long one 5-year note. The long 10-year and the short 10-year cancel each other out.  I am leaving the trade strategy as is for hypothetical purposes.  But in ‘real life’ trading, you would want to pick one spread or the other to trade, not both at the same time.

Gold/Silver Spread: Add On Bearish Confirmation

A Hat In the Ring

On February 18th the IMC blog entered a hypothetical short position in the June-July gold (100 oz.)/silver (x8,000/oz.) spread when it sold one 100 oz. June gold contract at approximately $1,225.80 (a value of $122,580) and simultaneously bought one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts at approximately $15.51 (a total value of $124,080). This initiates a short spread position at approximately -$1,500 (premium silver).

The initial liquidation trigger is a four-consecutive day close above +$500 (premium gold), which puts it above the 2015 multi-year peak of +$132, basis the nearest-futures contracts.

Looking To Add

The spread posted a new high on Friday. This slightly eclipsed the August high. A nice pullback this week would indicate that a Wash & Rinse pattern has been triggered. This would certainly be a good confirmation for the short position.

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

We are also running a contingency to add another spread on a close below the rising 50-day Moving Average, which is currently around -$3,849. A clean break below the 50-day MA for the first time since early November would signal a bearish trend change.

More Technical Confirmation

Once the June-July gold (100 oz.)/silver (x8,000/oz.) spread has broken the 50-day MA, we will be cheering for a break of a prior month’s low. This has not happened since October. Such an event would alter the price structure, further confirming our expectations for a bearish trend change.

Gold (100 oz.) Silver (8,000 oz.) spread weekly

Gold (100 oz.) Silver (8,000 oz.) spread weekly

Finally, an end-of-week close below the rising weekly 75-bar Moving Average (currently around -$9,170) in the gold (100 oz.)/silver (x8,000/oz.) spread and an end-of-week close below the rising weekly 75-bar Moving Average (currently around 74.3:1) in the gold/silver ratio for the first time in over three years months should seal the deal. At that point, we hope to have at least two profitable short entry signals still intact and working on plans to add even more.

Expect more posts on this spread as things progress.

Gold/Silver Spread: Time For a Short Sale

Ready For a Routing In the Ratio

I just finished up a guest post on the gold/silver ratio over at Martin Kronicle. You can view the article here. The gist of it is that the ratio has reached a level where it has made major reversals in the past. If history repeats, the downside potential over the next year or two is significant.

Gold Silver ratio weekly

Gold Silver ratio weekly

With a ratio of nearly 80:1, I am looking at the spread between 8,000 ounces of silver and 100 ounces of gold. A position in the futures market can be created by subtracting the difference between the value of one 100 oz. gold futures contract and a the value of the sum of one 5,000 oz. silver futures contract and three 1,000/oz. ‘mini’ silver futures contracts.

Chart Work

The June-July gold (100 oz.)/silver (x8,000/oz.) spread is trading less than $1,000 away from the August 26th contract high of -$688. This could potentially turn into a double top or, better yet, a Wash & Rinse sell signal. That’s where the spread clears the old high, only to fall back below it and indicate that a breakout attempt was a failure.

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

June-July Gold (100 oz.) Silver (8,000 oz.) spread daily

Furthermore, the spread has closed above the rising 50-day Moving Average every single day since early November. This constitutes as an uptrend. But a two-day close below the rising 50-day MA (currently around -$4,098) for the first time in over three months would potentially trigger a bearish trend change.

How Aggressive Traders Might Do This

If you were a gun-slinging, gasoline drinking, fly-by-the-seat-of-your-pants commodities trader, you could try to short the June-July gold (100 oz.)/silver (x8,000/oz.) spread somewhere up here and risk a four consecutive closes above ‘even money’.

The reason for the four consecutive days above even money is because the spread only stayed above ‘even money’ more than four days in a row just once during the financial crisis. Therefore, a one or two-day event could be a temporary blip.

Then you could double up once the spread makes a two-day close below the rising 50-day MA. After all, the initial position would be showing a profit and you’d be adding more once price confirms.

If You Are NOT Crazy…

On the other hand, what would a conservative, risk-managing, always solvent trader do?

Probably the exact same trade!

The only difference between the two traders is in the position-sizing. The gunslinger may bet the farm on this trade. The smart trader will put on a position size that only risks a small percentage of his capital. If the trade doesn’t work, the conservative trader gets nicked and the crazy trader gets beheaded. If/when the spread gives a new sell signal, the conservative trader can try again. Not the crazy trader, though. He’s blown out all of his capital.

Sometimes the only difference between a winning trader and a losing trader is the risk management strategy, not the entry/exit signals. Make it a priority to become an expert on risk management and position-sizing. That’s how you get rich. More importantly, that’s how you stay rich.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts at -$1,500 (premium silver). Initially, the spread will be liquidated on a four-consecutive day close above +$500 (premium gold).

Additionally, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts if the spread closes below the rising 50-day MA. Initially, the spread will be liquidated on a two-consecutive day close above the August high of -$688.

Cocoa/Sugar Spread: The ‘Add-On’ Criteria Was Met

Selling More Candy

On September 30th, the blog entered a hypothetical short position in the March cocoa/sugar (x2) spread at +$2,318.80 (premium cocoa). The spread was rolled to the May contracts on February 12th, so the position is now short from the equivalent of +$2,856. We’re risking to a two-consecutive day close above +$7,500 (premium cocoa).

The blog entered a second ‘add-on’ position this morning when the spread rallied to -$500 (premium sugar). This ‘add-on’ spread will initially be risked to a two-consecutive day close above +$2,000 (premium cocoa).

May Cocoa Sugar (x2) spread daily

May Cocoa Sugar (x2) spread daily

In mid-January the May cocoa/sugar (x2) spread posted a multi-month low of -$3,725.60 (premium sugar). A break below this level would keep the pattern of lower highs and lower lows intact, confirming the ongoing downtrend. If so, we will look for another setup to continue adding to the short position. With a minimum downside target of -$20,000 (premium sugar), we want to squeeze all the profits we can out of this move.

Cocoa/Sugar Spread: Rolling and Adding

Time to Roll and Time to Add

It’s almost Valentine’s Day. Time for love…and chocolate candy! Which reminds me: the First Notice Day for March cocoa is on Tuesday. So, outstanding long positions will have to be rolled before the long weekend. (The US markets are closed on Monday for President’s Day). Although we’re short the March cocoa and don’t necessarily have to roll yet, it may not be a bad idea to go ahead and do so. This keeps us in the contracts with the most liquidity.

The blog entered a hypothetical short position in the March cocoa/sugar (x2) spread at +$2,318.80 (premium cocoa) back on September 30th when the spread made a two-day close below the rising 50-day Moving Average for the first time in several months. We are simply going to scoot over to the May contracts.

The bearish trend change was triggered just a couple of weeks after the cocoa/sugar (x2) spread had reached a twenty-nine year high of +$8,559.60 (premium cocoa) on the weekly nearest-futures chart.

Even more interesting is the fact that the peak took the spread just past the double top at the 2002 and 2008 highs. This triggered a Wash & Rinse sell signal when the attempted breakout failed.

History Favors More Downside

In the past, rallies to +$4,500 (premium cocoa) or higher on the nearest-futures monthly chart lay the foundation for short sale opportunities in the cocoa/sugar (x2) spread. The trick, of course, is to identify the trend change and get in. After a couple of false starts, it appears that we were finally able to accomplish this.

Cocoa Sugar (x2) spread (nearest-futures) monthly

Cocoa Sugar (x2) spread (nearest-futures) monthly

Previous peaks at +$4,500 (premium cocoa) or higher were followed by bear market declines that took the spread back under -$20,000 (premium sugar). This level is our minimum downside target, so it still has quite a ways to go. Therefore, it makes sense to look for setups to add to the position and try to maximize the profits.

Current Price Pattern

Since October, the spread has closed below the weekly 50-bar Moving Average every single week. Prior to that, the weekly 50-bar MA had been acting as support on every pullback since April of ’09. Now that it has been broken, the weekly 50-bar MA has become technical resistance.

Cocoa Sugar (x2) spread (nearest-futures) weekly

Cocoa Sugar (x2) spread (nearest-futures) weekly

On the daily timeframe, the May cocoa/sugar (x2) spread spent most of October and November in a choppy trading range. After popping up nearly $3,000 from the October correction low and tagging the declining 75-day Moving Average in mid-December the spread rolled over and sank to new multi-month lows in the weeks that followed. This indicated that the 75-day MA is a resistance level to be monitored.

Therefore, is it any surprise that the recent bounce was stopped again by the 75-day MA on February 1st? And if that’s not enough, the rally also put it just $40 away from the Fibonacci .618 retracement of the decline from the mid-December peak.

In addition, the spread rallied about $3,600 off the January correction low. This was just a little bit bigger than the prior rally off the October correction low. Seems like it might be a good location to add to short positions.

May Cocoa Sugar (x2) spread dailyThe weekly 50-bar MA currently provides resistance at +$1,830 (premium cocoa) and the mid-December rally high is just a bit higher at +$2,006.40 (premium cocoa). This resistance area should be another fortress to stop the bulls if the spread does not roll over right around here. Therefore, placing protective buy stops above this area seems like a good strategy.

If a trader could sell the rally and risk just above the mid-December rally high, the risk would be somewhere between $2,000 and $2,500. With a minimum downside target of -$20,000 (premium sugar) the reward-to-risk on the trade is somewhere between 8-to-1 and 10-to-1.   That’s a good profile.

Trade Strategy:

On the hypothetical short March cocoa/sugar (x2) spread entered at +$2,318.80 (premium cocoa) on September 30th, roll to the May contracts at the market-on-close on Friday, February 12th. Risk to a two-consecutive day close above +$7,500 (premium cocoa).

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton May cocoa contract and simultaneously buy two 112,000 lb. May sugar contracts on a rally to -$500 (premium sugar). Initially, the ‘add-on’ spread will be liquidated on a two-consecutive day close above +$2,000 (premium cocoa).