Feeder/Corn Spread: Adjust the Spread for the Ratio

Recalibrate

The IMC blog is currently holding a short position in the August-September feeder/corn (x5) spread.  Due to a prior rollover, the spread is short from the equivalent of -$15,325 (premium the sum of the five corn contracts) on January 8th.

The spread has made a monster-size rally over the last three weeks as the corn market fell on its ear.  With a summer delivery contract in feeders, we’re now looking to roll into further out contracts.  In addition, the ratio of the spread is going to be adjusted.

At this week’s high, the ratio between the value of one November feeder contract and one December corn contract closed just above 4:1.  This matched the April high of 4.02:1 and was just a tad beyond the March high of 4:1.  The high for the year, set on January 4th, was only a bit further at 4.16:1.  By all appearances, it would seem that the ratio is at stiff resistance.

Nov-Dec Feeder Corn ratio daily

Nov-Dec Feeder Corn ratio daily

Looking at the last forty-five years of monthly closing prices, a ratio of 4:1 is a high level.  And keep in mind that it’s just coming off of an all-time high of 7.34:1!  There should be more downside ahead.

To normalize the spread between feeders and corn when the ratio is 4:1, you need to spread one feeder contract against four corn contracts.  Therefore, the blog is going to roll to the November-December spread and adjust the ratio down to normalize.

Trade Strategy:

Buy back the one 50,000 lb. August feeder cattle contract and simultaneously sell short one 50,000 lb. November feeder cattle contract at the market-on-close on Friday, July 8th.  Also, sell the five 5,000 bushel September corn contracts and simultaneously buy four 5,000 bushel December corn contracts at the market-on-close on Friday, July 8th.

This will roll the short Aug-Sep feeder/corn (x5) spread position into a short Nov-Dec feeder/corn (x4) spread position.  Risk the Nov-Dec spread to a two-day close above +$3k (premium feeders).

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