One Strike, But We’re Still Swingin’
The IMC blog initiated a hypothetical short position in the February cattle/hog (x2) spread at 0.925 (premium hogs) on October 3rd when the February cattle/hog ratio closes below 2:1.
The spread was liquidated at 7.725 (premium cattle) on October 5th because the ratio made a two-day close at new highs for the move. This resulted in a loss of -$3,460 on the trade.
The February contract ratio closed at a new contract high of 2.16:1 yesterday. This places it right on the doorstep of potential technical resistance at 2.21:1, which is the major Fibonacci .618 retracement of the entire nearest-futures decline from the March 2015 all-time high of 2.76:1 to the June 2016 two-year low of 1.32:1.
If the nearest-futures cattle/hog ratio doesn’t peak somewhere around here, a test of the November 2015 secondary high at 2.46:1 is possible.
Regardless of where the ratio finally tops, we do know this: History shows that the ratio has been unsustainable above 2:1. So despite the loss on this short sale attempt, the IMC blog still favors the short side of the February cattle/hog (x2) spread. Therefore, we won’t hesitate to get right back into the position if the spread rolls over again.
In light of this, the reentry setup we’ll employ is to get short on a break below the October 3rd reaction low where the first short sale attempt occurred. Once again, we will simply risk to new highs afterwards.
The blog will work a hypothetical order to sell one 50,000 lb. February live cattle contract and simultaneously buy two 50,000 lb. February lean hog contracts if the spread closes below 0.925 (premium hogs). Initially, the spread will be liquidated if the ratio makes a two-consecutive day close above the contract high that precedes the entry, which is currently at 7.725 (premium cattle).