Rollovers, Changes, and Other Housekeeping

The ‘To Do’ List

As we are about to close out the month and the first half of 2017, the IMC blog has a few spread positions that need to be rolled out to the more distant month contracts.  Also, there are current outstanding parameters for new trade positions that need to be adjusted and/or changed to longer-dated contracts.  For brevity’s sake, we’re gonna take care of all of this housekeeping in one single post instead of issuing multiple posts.

Rollovers

The blog entered a short position in the July Grain Basket spread (short one July soybean contract, long one July wheat contract, and long one July corn contract) at the equivalent of +$2.01 1/2 (premium beans) on February 13th.  Exit this spread and simultaneously enter a short position in the September Grain Basket spread (short one September soybean contract, long one September wheat contract, and long one September corn contract) at the market-on-close on Wednesday, June 28th.

The blog entered a short position in the July sugar/corn spread (short one July sugar contract and long one July corn contract) at the equivalent of +$3,025.80 (premium sugar) on February 13th and short an ‘add-on’ July sugar/corn spread at -$899.10 (premium corn) on April 26th.  Exit these spreads and simultaneously enter short positions in the Oct-Sep sugar/corn spread (short one October sugar contract and long one September corn contract) at the market-on-close on Wednesday, June 28th.

Parameter Changes

Last year, the IMC blog experimented with a value investing strategy known as scale trading.  We applied this strategy to the copper(x2)/gold spread in the second half of the year.  The trade campaign payed off as it netted a profit of nearly $72,000 in just under four months.  Therefore, we left standing orders in place to reenter if the spread returned to the qualifying price levels.

Currently, the blog is working orders to scale trade the December 2017 copper(x2)/gold spread.  We are going to change this to the July-June 2018 contracts in order to give ourselves lots and lots of time.  Therefore, the blog will cancel the current orders in the December 2017 spread and replace it with new orders to buy the July-June 2018 copper(x2)/gold spread (long two July copper contracts and short one June gold contract) on a close at -$5k or less, buy another one on a close at -$10k or less, buy another one on a close at -$15k or less, etc.  The purchase intervals are set every $5k lower.  Every position is to be liquidated on a close that is $5k or higher than the interval purchase level.  Note that the liquidation targets are based on the scale intervals, not the actual purchase price.  This means that any better-than-expected purchase prices will result in even bigger profits when it is finally liquidated.

Also, the blog has been working a hypothetical order to short the September copper/crude oil spread.  Cancel the parameters for the September contracts and replace it with new orders to short a December copper/crude oil spread (short December copper and long December crude oil) on a close below +$18k (premium copper).  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry (currently at $22,265).

Platinum/Gold Spread: Setup To Go Long

Record Extremes

The blog has been sitting with an unleveraged platinum/gold spread since September of 2015.  We’re running this position as an “investment”, ergo, the lack of leverage.

The reason for the investment is because the platinum/gold spread hit a record low, the platinum/gold ratio hit a thirty-three year low, and the time that platinum has been priced below gold is at a record duration.  Our thought is that this is like a stretched rubber band that’s due to snap back violently.

However, rubber bands will sometimes break.  That’s another reason we’re doing this experiment without any leverage!

Trader’s View

Investment experiment aside, the platinum/gold spread looks like it could be good for a speculative trade.

First of all, the spread recently tested last year’s record low and stated to recover.  The bounce faded off at the end of May, but a recovery above the May high could put it on an upward trajectory.

Also, the last two times the spread dropped this low (June 2016 and October 2016) it was soon followed by rallies of $182/oz. and $135/oz.

Now, the spread initially bounced off the early May multi-month low and then fizzled out just a couple of weeks later.  Last week it even closed just a mere five dollars away from the May 4th low.  That’s not how it played out the last two times, so it’s a little suspect.

But that brings me to my next observation…

Over the last year or so, the 50-day Moving Average has done a good job of defining the trend in the platinum/gold spread.  The bounce into mid-May stalled out once the spread encountered the declining 50-day MA and failed to clear it.

Platinum Gold spread (nearest-futures) daily

Platinum Gold spread (nearest-futures) daily

A two-day close above the 50-day Moving Average for the first time since February would turn the trend bullish again.  Having that happen right after a test of the prior lows that launched the last two sizable rallies could stack the deck even further in the buyer’s favor.

As a trader- not an investor, mind you- it seems that going long in the platinum/gold spread on a close above the 50-day MA and liquidating on a close below it would not be a half-bad strategy.

Trade Strategy:

Place a hypothetical contingency order to buy two 50 oz. October platinum futures contracts and simultaneously sell one 100 oz. October gold futures contracts if the nearest-futures spread makes a two-day close above the 50-day Moving Average.  If filled, exit the position on a two-day close below the 50-day Moving Average.

Sugar/Corn Spread: Roll and Add More

Bears Firmly In Control

The IMC blog entered a short position in the May sugar/corn spread on February 13th when the value of one sugar contract closed at a premium of +$3,251.30 over the value of one corn contract.

Early this month, the corn contract finally closed with the premium value.  That hasn’t happened since last June.  We are taking this as confirmation that the expected bear market is firmly intact.  Based on history, we expect to see this spread decline several thousand more dollars before it’s all said and done.

July Sugar Corn spread daily

July Sugar Corn spread daily

Today, we are going to do two things.  First, roll the May contracts to the July contracts.  First Notice Day is just a few days off.

Secondly, we are going to add to the short position.  The spread has been consolidating in a tight range for the last three weeks.  This pattern gives us a low-risk setup to get short on a breakout of the range and risk to the other side of the range.

Trade Strategy:

Buy back the short May sugar contract, sell one July sugar contract short, sell the May corn contract, and simultaneously buy one July corn contract at the market-on-close on Tuesday, April 25th.  Risk the July spread to a two-consecutive day close above +$4,000 (premium sugar). 

 “Add-On” Trade Strategy:

Place a hypothetical contingency order to sell one 112,000 lb. July sugar contract and simultaneously buy one 5,000 bushel July corn contract if the spread closes below the April 5th low of -$436.20 (premium corn).  If filled, liquidate the position on a three-consecutive day close above the April high (currently at +$437.10). 

Minneapolis/Kansas City Wheat Spread: Reset For the July Spread

Waiting for a Reversal

The IMC blog is holding a short position in the May Minneapolis/Kansas City wheat spread that was entered at +97 cents on February 10th.

The spread has rebounded sharply over the last two weeks and is testing the contract highs.  Therefore, we are going to liquidate the May spread and set parameters to short the July spread if it backs off.

July Minneapolis Kansas City Wheat spread daily

July Minneapolis Kansas City Wheat spread daily

We’ve established before that the Minneapolis hard red spring wheat is currently too pricey in comparison to the Kansas City hard red winter wheat.  It’s been this way for months, though.  While we still intend to be short, a breakout to new contract highs could keep it running indefinitely.  Hence, the strategy of waiting for the July spread to start back down before getting short again.

Trade Strategy:

Exit the hypothetical short position in the May Minneapolis/Kansas City wheat spread at the market-on-close on Tuesday, April 25th. 

Place a new order sell one July Minneapolis wheat contract and simultaneously buy one July Kansas City wheat contract if the spread closes below +$1.10.  If filled, risk a two-day close of three cents above the spread contract high that precedes the entry (currently at +$1.20 cents). 

Copper/Crude Oil Spread: Watching For a Reversal

Looking to Reenter

Back on December 1st, the IMC blog entered a short position in the copper/crude oil spread at the equivalent of +$12,870 (premium copper), due to rollovers.

September Copper Crude Oil spread daily

September Copper Crude Oil spread daily

The blog was last holding a May spread.  It was liquidated at the market-on-close on April 20th at +$13,280 (premium copper) because the crude contract was expiring.

We are now stalking the September copper/crude oil spread for a short sale.  The blog did not roll into the September contracts automatically because the spread tested support at the early February low last week and bounced.  The plan is to get into the spread only if it breaks the similar lows from early February and last week.

Copper Crude Oil spread monthly

Copper Crude Oil spread monthly

Currently, it appears that the spread is headed for a test of the contract high that was posted just last month at +$17,882.50.  A breakout to new highs could push it right over the +$20k mark in a heartbeat.  If so, we will revise our short sale criteria.  History shows that this spread has been a good short sale after surpassing the +$20k level.

Trade Strategy:

Place a hypothetical contingency order to sell one September copper contract and simultaneously buy one September crude oil contract if the spread closes below +$10,000 (premium copper).  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry (currently at $17,882.50). 

If the spread closes above +$20,000, change the parameters to enter a short position if the spread closes below +$17,000.  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry. 

 

Platinum/Gold Spread: Roll to Halloween Contracts

The Long Road

The blog is holding an unleveraged April platinum/gold spread from the equivalent of -$206.30 (premium gold).  It was originally entered in September of 2015.  Boy, it’s been a looooong year and a half.

Leveraged was briefly added in April 2016, but the ‘add-on’ investment position was liquidated just a couple of months later.  This was because the uptrend failed to materialize.

This unleveraged spread position is experimental as it deviates from our normal trading rules of getting in and then exiting if there is an adverse move.  The idea was that a mean reverting commodity spread at record lows (it hit an all-time low of -$343.30 on June 27th and then nearly matched it on October 21st when it traded to -$337.30) with a confirmation on the ratio (it registered a thirty-three year low of 0.7335:1 on October 21st) would be a temporary event.

Platinum Gold spread (nearest-futures) daily

Platinum Gold spread (nearest-futures) daily

Furthermore, platinum has been priced at a discount to gold for a record two years and two and a half months, which is substantially longer than the prior record inversion streak of one year and seven months (September 1981 and April 1983).  In terms of both price and time, the historic extremes argue that a major reversion is long overdue.

The $64,000 question, of course, is “when will it finally happen?!”

Until we get more clarity on the situation, we remain unleveraged on the position.  But once a breakout above -$200 takes place, we’ll pay closer attention.  When that happens, it will time for a challenge of the 2016 high at -$161.20.  If this hurdle is cleared, the odds are pretty good that this record bear market is finally over.  Until then, we’ll patiently roll the contracts and bide our time.

Investment Strategy:

For tracking purposes, the blog will liquidate the long April platinum/gold spread investment position and simultaneously enter a long investment position in the October platinum/gold spread at the market-on-close on Tuesday, March 28th.  There are currently no liquidation parameters for this low-leverage position.  Factoring in the results of one ‘add-on’ investment position, the bankroll for this spread is currently $101,920.

Crude/Nat Gas Spread: Catching The Falling Knife

Spreading the Energies

Some of my favorite spreads are in the energy sector.  In particular, I love to trade the crack spreads.  But there’s also another lesser-known energy spread in my bag of tricks: crude oil against natural gas.

A few years ago, the correlation between crude and nat gas broke down.  It lasted for a few years and was not resolved until 2014.  This made for some tough sledding for anyone trying to trade the two markets against each other.  But since the correlation has been back to normal over the last three years, the odds of successfully trading the spread have gone up.  To that end, it looks like a buying opportunity is shaping up right now.

Making Plans for Labor Day?!

Two days ago marked the first day of spring.  Ironically, the trade opportunity that popped up on my radar screen yesterday is for the Labor Day (September) contracts.  I guess that’s why these are called futures contracts, right?

A crude oil futures contract controls 1,000 barrels of crude and a natural gas futures contract controls 10,000 MMBtu (million British thermal units) of nat gas.  To simplify the spread, I plot the difference between the actual values of the contracts.

Over the last couple of years, one September crude oil contract has been worth anywhere from 40% more to a little more than double the value of one September natural gas contract.  Therefore, the blog has been plotting the spread between one crude oil contract and the sum of the value of two natural gas contracts.

Price Parameters

Yesterday the September crude oil/natural gas (x2) spread closed at -$15,930 (premium nat gas).  This was the lowest price it has been in fourteen months.

Notice that this was only the fourth time in the last year that the spread has closed at -$15,500 or lower.  The lowest closing price was the January 20, 2016 low of -$16,170 and the longest that it ever closed at -$15,500 or lower was two consecutive days.

September crude oil natural gas (x2) spread daily

September crude oil natural gas (x2) spread daily

Actually, I fudged on that count just slightly.  The August 2, 2016 close was -$15,430.  That’s only $70 away from the -$15,500 threshold, which is close enough in horseshoes and hand grenades.  So we’ll say it’s close enough for spread trading, too.

Each of the dips to -$15,500 or lower was followed by rebounds that took the September crude oil/natural gas (x2) spread north of -$6,000.  Now interestingly enough, each close above -$6,000 was also a short-lived excursion as well.  Once the spread achieved this level, it soon rolled over and plunged again.  It’s been a perfect trading range for nearly a year and a half.

In light of this, it looks like the trade opportunity here is to buy the spread now and look for a rally above -$6,000 before taking profits.  Also, an ‘add-on’ position could be purchased once the rebound starts.  So that’s exactly how the IMC blog is gonna play it.

Ratio Confirmation

The ratio between the values of a September crude oil contract and a September natural gas contract confirm what we’re seeing in the spread.  The ratio closed at 1.51:1 yesterday.  The last three times it closed at 1.52:1 or lower, a major recovery soon followed.

The biggest challenge for the ratio’s recovery happened in January 2016.  The ratio closed at 1.52:1 on January 12th and didn’t fully recover above this level until two weeks later.  During this time, the contract low of 1.4:1 was established on January 20th.

September crude oil natural gas ratio daily

September crude oil natural gas ratio daily

In the grand scheme of things, though, this extended stay at 1.52:1 or lower was not all that dramatic because the spread only stayed at -$15,500 or lower for two days.  This is why using both the spread and the ratio together is a good idea.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one September 1,000 barrel crude oil contract and simultaneously selling two September 10,000 MMBtu (million British thermal units) natural gas contracts at -$15,500 (premium nat gas) or better.  Initially, the spread will be liquidated on a three-day close below -$16,500.

Trade Strategy for ‘Add-On’ Position:

For tracking purposes, the blog will make a hypothetical trade by buying one September 1,000 barrel crude oil contract and simultaneously selling two September 10,000 MMBtu (million British thermal units) natural gas contracts on a close at -$13,000 (premium nat gas) or higher.  Initially, this ‘add-on’ spread will be liquidated on a two-day close below -$15,500.

Grain Basket Spread: Is the Bear Coming Out of Hibernation?

The Grain Basket Spread

I’ve traded the spread between soybeans and the sum of wheat and corn for many years and I’ve also posted about it on this blog a few times.  I nicknamed this spread the grain basket.  And sometimes it has been known to make baskets of money!  Based on current conditions, it appears that the grain basket spread may be shaping up for a new trading opportunity.

Price Correlation

Historically, the price relationship between soybeans, wheat, and corn has mostly been a highly-correlated affair.  Notice the word “mostly.”  There have been times when the correlation seemed to weaken.

For instance, we’ve seen a drought in Russia scorch the wheat crops and send wheat prices rocketing while it had no effect on world prices of beans and corn.  There have also been major hits to the South American bean crop that sent US soybeans to the moon, while corn was up modestly and wheat did nothing.

soybeans-wheat-corn-overlay-nearest-futures-monthly

Soybeans Wheat Corn overlay (nearest-futures) monthly

These divergent moves produced a drop in correlation, but they have always proved to be temporary events.  Over the long haul, the three grains have always gotten back in sync.  That’s what makes them such an attractive candidate for spread trades.

Historical Boundaries

As readers know, the IMC blog only takes an interest in the spreads that are at historical extremes.  Due to the mean-reverting nature of commodities, we believe that a spread trading at an historical extreme has a high-probability of making a sizable reversal and is worth betting on.  The trick, of course, is timing that reversal.

So what constitutes as an historical extreme?  Good question.  Here’s my way of looking at it.

Initially, a spread that has moved more than two standard deviations from the mean is a good candidate.  Remember, roughly 95% of all data values in a data distribution fall within two standard deviations from the mean.  So once a spread gets past the two standard deviation signpost, it’s stretched pretty thin.

Now, if you want to break it down into even simpler terms and shoot for a less technical answer, how about this: a spread is considered to be trading at an historical extreme when it reaches a price level that has only been reached infrequently (if ever) and has never been a sustainable level.

Using the grain basket spread as our example, take a look at nearly half a century of monthly price history.  Notice that there have only been a total of six bull markets that ran the spread up to three dollars or higher (premium beans).  Also, the longest consecutive run of month-end closes at three dollars or higher was four months.  Therefore, we can consider the spread to be “expensive” and at an historical extreme when beans command a premium of $3-per-bushel over the sum of wheat and corn.

grain-basket-spread-nearest-futures-monthly

Grain Basket spread (nearest-futures) monthly

Conversely, we can consider the grain basket spread to be “dirt cheap” and at an historical extreme when the sum of wheat and corn gain the upper hand and trade at a premium of two dollars or more over the price of soybeans.  Only three bear markets in the last fifty years have brought the spread to levels that low!

Grain Expectations

First off, let’s establish this basic and very important fact: It is absolutely impossible to know with certainly what the future will be.  Otherwise, palm readers and tarot card shops would not be located on the sketchy side of town.  And people who use Ouija boards and Magic 8 Balls would have their own yachts.

But what we can know is what the outcome probabilities are for future events.

There is a very important difference here.

That being said, notice that all six of the bull markets that ran the grain basket spread to three dollars or higher (premium beans) were followed by bear markets that erased the entire premium from the beans.

Therefore, a trader who gets positioned on the short side of the grain basket spread after a reversal signal occurs at $3-per-bushel or higher should be targeting a return to ‘even money’ or lower.  This will help you assess the reward-to-risk ratio on your trade setups and pyramid positions.

The Improbable Still Happens

Although I just picked on the fortune tellers for trying to divine the future, it does not mean that people like us who focus on the probabilities are completely off the hook.  Some people tend to forget that probabilities are not guarantees.  The improbable still happens!  And sometimes more often than we’d like to think.

Consider the Chicago Cubs winning the World Series last year or the Patriots coming back to win the Super Bowl in overtime last night…

Or the Brexit vote last summer or Trump’s election victory three months ago!

This is why you have to learn to bet according to the probabilities to become a good trader, but then you have to learn to manage risk according to the possibilities to become a great trader.

Current Outlook

The May grain basket spread (the difference between the price of one May soybean contract and the sum of one May wheat contract and one May corn contract) broke out of a multi-month trading range at the end of 2015 and has been trending higher since then.

During this bull run, the spread stayed above technical support at the rising 100-day Moving Average…until a month ago when it made a two-day close below the 100-day MA for the first time in over a year.

may-grain-basket-spread-dailyThe spread quickly rebounded and recovered nearly three-quarters of the pullback from the December peak.  However, prices softened over the last couple of weeks and the 100-day MA is being tested once again.

If the mid-January bounce turns out to be a secondary (lower) high and the May grain basket spread closes back under the 100-day MA, it may be time to start betting that the bull market is over.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 5,000 bushel May soybean contract and simultaneously buying one 5,000 bushel May wheat contract and buying one 5,000 bushel May corn contract if the spread between soybeans and the sum of the wheat and corn closes below the rising 100-day Moving Average (currently at +$2.22 1/4).  If filled, risk a two-day close of 5 cents above the contract high that precedes the entry. 

Cocoa/Sugar Spread: Adjust the Ratio

Recalibration

The IMC blog is still positioned on the right side of the bear market in the cocoa/sugar (x2) spread.  Currently, we are short a March cocoa/sugar (x2) spread from the equivalent of +$37.20 (premium cocoa) that was entered on September 30th of 2015!  We added a second ‘add-on’ position at the equivalent of -$3,319 (premium sugar) on February 18th and then we added a third ‘add-on’ position at the equivalent of -$6,528.40 (premium sugar) on April 19th.

The spread continued to decline so much that when our next setup to add more occurred, we decided to spread one cocoa contract against just one sugar contract instead of two sugar contracts this time.  So on November 21st, the blog sold a fourth ‘add-on’ position at +$1,550.40 (premium cocoa).

cocoa-sugar-spread-nearest-futures-weeklyWhat we did not do, however, was recalibrate our older spread positions to reflect the current ratio of approximately 1:1.  Given the fact that the prior bear market declines in the cocoa/sugar spread did not end until one cocoa contract had a premium of +$4,000 or more over one sugar contract, it makes sense to adjust our position to reflect the current ratio of the cocoa/sugar relationship and stay short.

Since there’s no time like the present, we want to go ahead and get that done.  We are going to make this our last act of 2016!

Trade Strategy:

On the short positions in the March cocoa/sugar (x2) spread entered at the equivalent of +$37.20 (premium cocoa), the equivalent of -$3,319 (premium sugar), and the equivalent of -$6,528.40 (premium sugar), exit one of the two sugar contracts in each spread at the market-on-close on Thursday, December 29th.  This will change the ratio for each spread to 1:1.  Risk all four spreads to a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.

 

Cocoa/Sugar Spread: Another Short Sale Setup

Riding the Bear

The IMC blog has been in a profitable trade in the cocoa/sugar (x2) spread for over a year now.  Based on adjustments for rollovers, we’re holding a short position in the March cocoa/sugar (x2) spread that was entered on September 30th at the equivalent of +$37.20 (premium cocoa), a second ‘add-on’ position that was entered on February 18th, at the equivalent of -$3,319 (premium sugar), and a third ‘add-on’ position that was entered on April 19th at the equivalent of -$6,528.40 (premium sugar).

march-cocoa-sugar-x2-spread-daily-75-day-ma

March Cocoa Sugar (x2) spread daily (75-day MA)

Over the last week and a half, the spread has bounced from trading near contract lows to closing just above resistance between the November 1st bounce high of -$21,195.60 and the declining 75-day Moving Average around -$21,336.20.  It’s do-or-die right here.

On the nearest-futures chart, the cocoa/sugar (x2) spread is sitting just below that same resistance level between the November 1st bounce high and the declining 75-day Moving Average.

cocoa-sugar-x2-spread-nearest-futures-daily-75-day-ma

Cocoa Sugar (x2) spread (nearest-futures) daily (75-day MA)

In addition, the nearest-futures spread has currently rallied as much as $4,158.80 from the recent low.  Since the bull market ended in September of 2015, the spread has made four other notable bounces of $5,076.40 off the January low, $5,679.20 off the March low, $4,041.60 off the July low, and $5,014 off the October low.  Based on this symmetry, the bounce could be close to completed.

Reading the Ratio

The ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract recently tagged 1:1 for the first time in over four years.  Prior bull markets that peaked at a ratio of 2.5:1 or higher were followed by multi-year bear markets that took the ratio below 0.8:1 each time.  Therefore, the current bounce could be nothing more than another bear market rally.  These are short sale opportunities and will remain so until the trend changes.

Due the decline in the ratio, the IMC blog will adapt by taking additional ‘add-on’ signals for a spread between one cocoa contract and one sugar contract.  This keeps it more dollar neutral.

march-cocoa-sugar-spread-daily-50-day-ma

March Cocoa Sugar spread daily (50-day MA)

Viewing the March cocoa/sugar spread, one can easily see that the downtrend remains fully intact and that bounces into the declining 50-day Moving Average have been selling opportunities.  Therefore, we have a green light to add to short positions right here.

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton March cocoa contract and simultaneously buy one 112,000 lb. March sugar contracts at +$1,550 (premium cocoa) or better.  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above +$3,000 (premium cocoa).