Soy Meal/Bean Oil Spread: Time to Cover the Shorts

Ready To Pull the Trigger

Back in the late spring, the ratio between the value of one 100-ton soy meal futures contract and the value of one 60,000 lb. bean oil contract reached 2:1.  Since the ratio has only been at 2:1 or higher a handful of times in the last forty-five years, we knew that a short sale opportunity was in the making.

We initiated a short position on July 7th in the soy meal/bean oil (x2) spread when the spread closed below the rising 30-day Moving Average for the first time in three months, triggering a bearish trend change signal.

Due to the rapid descent, we were able to quickly pyramid the positions by adding spreads four more times.

Initially, we started the position in the September futures contracts.  Then we rolled to the current December contracts.  Taking into account the carry charge, the short December soy meal/bean oil (x2) spread positions were entered at the equivalent of -$432 (premium bean oil), the equivalent of -$4,318, the equivalent of -$6,824, the equivalent of -$8,900, and -$11,196.

The average entry price on the five short sale price points is -$6,334.

The Soy Meal Market

December soy meal appears to have started a move higher today.  There are three technical signals for this.

First, it rocketed to the highest price in over two months.  This is a Turtle-style or Donchian Band breakout signal that could attract classic trend followers.

Second, the market is set to make a two-day close above the declining 50-day MA for the first time since the first half of July.  This would be a bullish trend change signal.  The last time this occurred was in mid-March and trading it would have put you long right before the huge run into June occurred.

december-soy-meal-daily

December Soy Meal daily

Third, December soy meal is poised to close well-above the 200-day MA for the first time since late August.  Many macro traders use the 200-day MA to determine a market’s trend.

This is all backed up by the seasonal pattern that shows that meal usually establishes a major bottom in October.  Looks like it’s right on time this year!

The Bean Oil Market

While meal is just starting to turn bullish, the bean oil market has been in an uptrend for quite some time.  First, it bottomed in late July.  Then in early August, it made a two-day close above the declining 50-day MA for the first time in nearly three and a half months.  The market did close back under the 50-day MA in mid-September, but it turned around two days later and the uptrend resumed.

december-bean-oil-daily

December Bean Oil daily

This week the market ran into a potential problem.  On Monday the December bean oil cleared price resistance at the April 21st contract high of 35.81.  But after a one-day close above this high, the contract dipped back under it and sank to a four-day low today.  This failed breakout attempt triggered a Wash & Rinse sell signal.

bean-oil-nearest-futures-weekly

Bean Oil (nearest-futures) weekly

Furthermore, bean oil hit major technical headwinds on the weekly timeframe.  The market entered a resistance zone between the 2015 nearest-futures high of 35.29 and the 2010 nearest-futures low of 35.75 (old price support, once it has been broken, become new price resistance).  It is also nearing the declining weekly 200-bar MA at 36.51.  A close back under the 2015 high of 35.29 and the April 2016 nearest-futures high of 35.14 would trigger a Wash & Rinse sell signal on the weekly timeframe as well.

The Spread Situation

With soy meal just starting a potential run to the upside…

And bean oil potentially topping…

The soy meal/bean oil (x2) spread is vulnerable to a sizable reversal to the upside.

december-2016-soy-meal-bean-oil-x2-spread-daily

December 2016 Soy Meal Bean Oil (x2) spread daily

Recall that we set the intervals for the ‘add-on’ entry and exit levels at $2k.  This was based on the spreads volatility.  Currently, the December spread has rallied as much as $2,746 off Monday’s low.  This ‘overbalancing of price’ could be an indication that the trend in the spread is changing.

A two-day close above the declining 30-day MA for the first time since the first week of July would confirm it.  In light of this, we want to go ahead and exit stage right!

Trade Strategy:

On the five short December soy meal/bean oil (x2) spreads entered at the equivalent of -$432 (premium bean oil), the equivalent of -$4,318, the equivalent of -$6,824, the equivalent of -$8,900, and -$11,196, exit at -$9,712 or better.

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