Time to Roll
The IMC blog entered a short position in the April-May feeder/corn (x5) spread at -$11,462.50 (premium the sum of the five corn contracts) on January 8th. Since the First Notice Day for both of these markets hits next week, it’s time to roll over.
At yesterday’s new contract low of nearly -$24k, it would appear that the April-May feeder/corn (x5) spread has already declined enough. However, history indicates that the spread could still have significant downside ahead.
First of all, the spreads prior excursions to ‘even money’ or better (where one feeder contract was worth at least the same value as the sum of five corn contracts) were followed by multi-month/multi-year declines to -$50k, -$38k, and -$133k (!).
In addition, the ratio between a 50,000 lb. feeder cattle contract and a 5,000 bushel corn contract is a little under 4:1 today. The normal level for the ratio is somewhere around 3:1.
The ratio peaked at an eye-popping record high of nearly 7.5:1 about a year and a half ago. It has been working its way lower since. Prior peaks near 5:1 or higher were followed by declines that put the ratio below 3:1. The 1987 peak of 4.98:1 was followed by a decline to nearly 2:1 the following year and the 2005 peak of 6.15:1 was followed by a decline to 1.5:1 over the next two and a half years.
To reach a ratio of 3:1, the feeder/corn (x5) spread would have to decline to somewhere between -$39k and -$50k. That’s another $18,000 to $28,000 from where the spread sits today. And if the ratio is heading to 2:1 or lower…well, I’ll let you do the math on that. It’s certainly worth your while to be short.
We are going to roll the position to the August-September spread. We will also monitor the spread vigilantly for setups to add to the position.
Buy the one 50,000 lb. April feeder cattle contract and simultaneously sell one 50,000 lb. August feeder cattle contract at the market-on-close on Friday, April 22nd. Also, sell the five 5,000 bushel May corn contracts and simultaneously buy five 5,000 bushel September corn contracts at the market-on-close on Friday, April 22nd. This will roll the short April-May feeder/corn (x5) spread position into an August-September feeder/corn (x5) spread position. Risk the August-September spread to a two-day close above -$9,000 (premium the sum of the five corn contracts).