Feeder/Corn Spread: Will the Breakout Last?

Sidelined

The IMC blog entered a short position in the feeder/corn spread on January 8th.  After a series of rollovers and ratio adjustments, the last position was a Nov-Dec feeder/corn (x4) spread short from the equivalent of -$1,237.50 (premium corn).

The spread was liquidated at +$3,775 (premium feeders) on August 4th, resulting in a loss of -$5,012.50.

The Current Stampede

The Nov-Dec feeder/corn (x4) spread posted a new contract high of +$3,837.50 (premium feeders).  The nearest-futures spread is at even loftier heights as it reached a nearly seven-month high of +$10,025 (premium feeders).  This is bullish.

Feeder Corn (x4) spread (nearest-futures) daily

Feeder Corn (x4) spread (nearest-futures) daily

With the nearest-futures spread clearing the widely-watched 200-day Moving Average for the first time in a year, the door is open for a run to the midpoint of the entire bear market decline from the 2014 all-time high.  This would put it somewhere in the neighborhood of +$18,500 (premium feeders).

Feeder Corn ratio (nearest-futures) weekly

Feeder Corn ratio (nearest-futures) weekly

Furthermore, the nearest-futures feeder/corn ratio is back up to 4.6:1.  Recall that the ratio is historically extreme and unsustainable when it gets above 4.8:1 (nearly five-to-one).  In the past, ratio peaks above 4.8:1 have been followed by declines back below 3:1.  This last bear market only made it to 3.14:1.  So keep your eyes open.

Who’s the Sucker?

Since the Nov-Dec feeder/corn (x4) spread is at new record highs and still trading at a discount of several thousand dollars to the nearest-futures spread, there’s plenty of upside potential.

Nov-Dec Feeder Corn (x4) spread daily

Nov-Dec Feeder Corn (x4) spread daily

However, markets sometimes breakout and suck everyone in before rolling over and crushing the unsuspecting.  Now that the spread has broken out to new contract highs, a close back below support at the July 29th pullback low of -$925 (premium corn) and a close below the rising 20-day Moving Average (currently around -$1,045) for the first time since mid-June could be a strong clue that this breakout attempt was a sham.  If so, it might be worth taking a crack at the short side again.

Trade Strategy:

Place a hypothetical order to sell short one 50,000 lb. November feeder cattle contract and simultaneously buy four 5,000 bushel December corn contracts if the Nov-Dec feeder/corn (x4) spread closes below the July 29th low of -$925 (premium corn).  If filled, risk a two-day close $500 above the contract high that precedes the entry.

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