The IMC blog shorted the September soy meal/bean oil (x2) spread at +$500 (premium meal) on July 7th. Prior bull markets that put the meal side of the spread at a premium were followed by bear markets that took the soy meal contract to a discount of at least $10k to a pair of bean oil contracts.
As a matter of fact, a majority of the bear markets crushed the spread down to -$20,000 (premium bean oil) or lower. So with the spread hitting a two-month low of roughly -$2,500 this morning, this means there’s still a lot of potential money to take off the table in this trade. Therefore, the blog is going to pyramid this position by progressively adding more spreads as the price decline continues.
Setting the Intervals
As we explained in the post on the soy meal (x2)/soybean spread, a method I like to use for determining the ‘add-on’ levels or intervals is to measure the countertrend moves of the prevailing trend. Then we set the intervals at a larger size than the countertrend bounces in order to give the spread the room it needs for countertrend moves without running a high risk of getting our exit parameters triggered. In other words, we are measuring the volatility and trading around those measurements.
The September soy meal/bean oil (x2) spread peaked just three weeks ago. So far, the largest countertrend bounce has been $1,116. Given the fact that the spread has dropped nearly $2,500 over the last four days, the small size of the countertrend bounce seems suspect. Therefore, I want to take a look at the countertrend pullbacks that the spread endured during the three-month bull run off the early April low.
Until mid-June, the largest pullback that the spread made was $1,362. It finally saw a correction of $2,130 off the mid-June high and a final top was established a couple of weeks later.
So up until mid-June the countertrend moves maxed out below $1,400 and since the current peak, the countertrend bounce was just over $1,100. This indicates that the volatility is not that great. We’ll use that to our advantage and set the ‘add-on’ intervals at $2,000 to add to the position. This is several hundred dollars more than the typical countertrend moves on the ride up and, so far, on the way down.
‘Add-On’ Trade Strategy:
The blog will sell another September soy meal/bean oil (x2) spread on a close below -$2,500 (premium bean oil). If filled, exit on a two-day close of $2,000 or more above the entry price.
If the ‘add-on’ order is filled, sell a third September soy meal/bean oil (x2) spread on a close $2,000 below the entry price of the prior ‘add-on’ position. If filled, exit on a two-day close of $2,000 or more above the entry price.
If the second ‘add-on’ order is filled, sell a fourth September soy meal/bean oil (x2) spread on a close $2,000 below the entry price of the most recent ‘add-on’ position. If filled, exit on a two-day close of $2,000 or more above the entry price.
To enter a short position in this spread, sell one 100-ton September soy meal contract and simultaneously buy two 60,000 lb. September bean oil contracts.