Live Cattle/Lean Hog Spread: Liquidate the Short Position

Live Cattle/Lean Hog Spread

The IMC blog entered a hypothetical short position in the December live cattle/lean hog spread at 83.50 (premium cattle) on April 15th. Initially, we were going to risk a close above 90.00 (premium cattle) so that it would take a breakout to new contract highs to knock us out.

After sitting in a trading range for several weeks, the December live cattle/lean hog spread made a breakout to the upside. Today will likely be the third-consecutive day that it closes back above the 84-cent mark as well. This price action argues for a test of the contract highs. Therefore, it may be prudent to go ahead and take a partial loss right here in the hopes that we can reposition at a higher level.

December Live Cattle Lean Hog spread 3-minute

December Live Cattle Lean Hog spread 3-minute

Despite the recent bounce, it is important to keep the big picture in mind. Both the spread and the ratio between live cattle and lean hogs are at high levels that are rare by historical standards. In the past, both the spread and the ratio have always turned back down and gone to levels that are less than half of where they are now. Therefore, we are still very excited about the short side of this trade. The current liquidation is just a little bit of fine-tuning.

Trade Strategy:

Buy back the one short 40,000 lb. December live cattle contract and simultaneously sell the one 40,000 lb. December lean hog contract at a spread of 85.75 or better.

However, let’s keep the ‘add-on’ order working to sell one 40,000 lb. December live cattle contract and simultaneously buy one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). If filled, risk a two-day close .50 points above the highest price that follows the April low. That way, we have a setup that gets us back in the spread in the event that our current bailout is ill-timed.

Live Cattle/Lean Hog Spread: An ‘Add-On’ Setup For a Short Sale

Live Cattle/Lean Hog Spread

The blog is currently holding a hypothetical short position in the December live cattle/lean hog spread entered at approximately 83.50 (premium cattle) on April 7th.

The live cattle/lean hog spread exploded to new record highs in Q4 of 2014. Even though it has backed off from the peak, it is still extremely overpriced. The December spread is currently around 82.00 (premium cattle). Historically, this spread was usually considered to be very expensive whenever it reached 35.00! Previous runs to this level were followed by a reversal that sent the live cattle/lean hog spread back below 20.00 (premium cattle). Therefore, it still has quite a low of downside potential.

Live Cattle Lean Hog spread monthly

Live Cattle Lean Hog spread monthly

The December live cattle/lean hog spread established a multi-month low of 74.35 on December 16th. After an explosive two-week rally, the spread backed off again and bottomed in February just above the December low. From there it launched a one-month run into new contract highs.

The Fibonacci .618 retracement of the entire move from the December 16th low to the March 23rd contract high offered support at 80.17. The December live cattle/lean hog spread neared this level in mid-April when it bottomed at 80.47 and bounced.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

Currently, the spread finds near-term support between the April correction low and the Fibonacci .618 retracement. A break below this level should confirm that the downtrend from the March peak is still in play. This would give traders a reason to initiate another short position. Risking to just beyond the current bounce off the April low provides a low-risk setup on the trade as well. And with price expected to eventually reach a significantly lower level, the reward-to-risk ratio is very attractive on this trade. It could be as high as 12:1! Therefore, aggressive spread traders could use this setup as an opportunity to add to short positions.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical ‘add-on’ trade by selling one 40,000 lb. December live cattle contract and simultaneously buying one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). If filled, risk a two-day close .50 points above the May high that precedes the entry.

Cattle Crush Spread: Book The Profits

Cattle Crush Spread

The IMC blog is holding hypothetical long positions in the August-April-May 6:3:2 cattle crush spread. The initial position was entered at -$10,860 (premium the sum of the feeders and corn) on October 27th and an ‘add-on’ position was entered at -$350 (premium the sum of the feeders and corn) on February 23rd.

The spread endured a wicked two-month decline from the contract high into the early April low. Since then, it has recovered about two-thirds of the decline and the cattle value has a premium for the first time since early March.

Aug-April-May 2015 Cattle Crush spread hourly

Aug-April-May 2015 Cattle Crush spread hourly

So here’s the dilemma: Next week is the Last Trading Day for the April feeder contract and it’s the First Notice Day for the May corn contract. We are looking out to the December-August-July 6:3:2 cattle crush spread, but it’s a few thousand dollars higher. Therefore, our opinion is that we should bag the profits here. We’ll get to the sidelines and then start monitoring the December-August-July 6:3:2 cattle crush spread for new setups.

Trade Strategy:

For the long August-April-May 6:3:2 cattle crush spread entered at -$10,860 (premium the sum of the feeders and corn) on October 27th and the ‘add-on’ position entered at -$350 (premium the sum of the feeders and corn) on February 23rd, exit right here at +$200 or better. This will yield a profit of +$11,060 on the initial position and a profit of +$550 on the ‘add-on’ position.

Also, cancel the setup to add another on a close above +$6k (premium live cattle).

Live Cattle/Lean Hog Spread: Entry Price Elected

Live Cattle/Lean Hog Spread

The IMC blog was working a hypothetical order to sell the December live cattle/lean hog spread on a bounce to 83.50 (premium cattle). This happened today. The 40,000 lb. December live cattle contract would have been sold short at approximately 151.05 and the 40,000 lb. December lean hog contract would have been purchased at approximately 67.55.

This initial exit plan is to bail out on a two-consecutive day close above 90.00 (premium cattle). The spread would have to make a sustained breakout to new contract highs to knock the position out.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

The December live cattle/lean hog spread ended the day at 2.24:1. This is quite extreme. History indicates that the ratio should go back down to just half this level.

The spread is an even bigger outlier. Historically, the live cattle/lean hog spread has always gone back below 20.00 (premium cattle) after a big run. If this happens to the December spread it would knock off a whopping three-quarters of the current price premium. Therefore, aggressive spread traders should be watching for setups to add to short positions on the way down.

Feeder Cattle/Live Cattle Spread: Roll To The August Contracts

Feeders/Live Cattle Spread

On December 12th the blog entered a hypothetical short position in the April feeder/live cattle spread at approximately 59.70 (premium feeders). The initial exit criterion was a two-consecutive day close above 69.25.

Since we are dealing with two different contract sizes (50,000 lbs. of feeder cattle and 40,000 lbs. of live cattle), we are going to convert this spread to the difference between the contract values instead of the market prices. This will make it easier for us to track.

April Feeder Cattle Live Cattle spread daily

April Feeder Cattle Live Cattle spread daily

Hypothetically, we entered the April feeder cattle contract at a price of 221.10. This values the contract at $110,550. We also entered the April live cattle contract at a price of 161.40. This values the contract at $64,560. Therefore, the spread was initiated at $45,990 (premium feeders). Risking to a new high would mean a two-consecutive day close above $51,000.

Feeder Cattle Live Cattle ratio monthly

Feeder Cattle Live Cattle ratio monthly

When the spread was initiated, the ratio between the value of the feeder contract and the value of the live cattle contract was 1.71:1. Historically, the ratio is expensive whenever it reaches 1.6:1 or higher. In nearly half a century, there are less than a handful of times where the ratio reached 1.7:1 or higher (on a monthly closing basis). Therefore, we know that it is still at unsustainable levels. History shows that the ratio has always turned over and dropped back down to 1.3:1 or lower after an excursion to 1.6:1 or higher. Therefore, the probabilities are still quite favorable that more downside is coming.

August Feeder Cattle Live Cattle spread daily

August Feeder Cattle Live Cattle spread daily

Fortunately, the August feeder/live cattle spread is trading at a premium of a few thousand dollars over the April spread. Also, the current August ratio of 1.8:1 is higher than the contract high for the April ratio. This puts us in a favorable position for rollovers since it would put us in a short August spread at the equivalent of $50k or higher. Looking at the last forty years of history, we can see that anything above $15k used to be considered ‘pricey’ so the explosive move off the 2013 low to new record highs for several months in a row was one for the history books. If the reversion to the mean has really begun in the feeder/live cattle spread, there could be quite a lot of money to be made on the way down.

Trade Strategy:

For tracking purposes, the blog will roll the April feeder/live cattle spread to the August feeder/live cattle spread at the market-on-close on Tuesday, April 14th. Risk the August spread to a two-consecutive day close above +$56k.

Live Cattle/Lean Hog Spread: Updated Parameters For The Reentry Trade

Live Cattle/Lean Hog Spread

For the last couple of months, the IMC blog has been working a hypothetical order to initiate a short sale in the April live cattle/lean hog spread on a break below the December low of 73.65. April livestock contracts start going off the board this week, so this spread trade needs to be revised.

We now have our eye on the Christmas live cattle/lean hog spread. The summer spreads are trading at a steep discount to the April spread, but the December spread is priced nearly 14 cents ($5,600 on a single contract basis) above the summer spreads.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

The December live cattle/lean hog spread peaked just below 84 cents (premium cattle) in October, December and January. It broke through this resistance barrier in March and peaked at a contract high of 89.625. Once the 84-cent resistance level was conquered, it turned into a floor of support.

Last week the December live cattle/lean hog spread made a two-day close back below 84 cents. This indicates that the breakout is over. Therefore, a short sale is warranted.

December Live Cattle Lean Hog ratio daily

December Live Cattle Lean Hog ratio daily

The ratio between the December live cattle and December hogs peaked at 2.45:1 on the first day of spring (March 20th). It has since dropped to 2.2:1. This is the biggest decline that the ratio has experienced in the last several months. It creates an overbalancing of price, which is indicative of a trend change.

Live Cattle Lean Hog ratio weekly

Live Cattle Lean Hog ratio weekly

Let’s get some perspective of what 2.2:1 means historically. In the last +40 years, the cattle/hog ratio has only been as high as 2:1 on five different occasions (including the current excursion). This is based on the weekly closing prices of the nearest-futures contract. The previous four occurrences were followed by declines to at least either side of 1:1. This took the ratio well below a more normal level of 1.4:1. In other words, it acted like a pendulum that swung from one extreme to the other. If that’s the case, it seems that the probabilities are favorable that the live cattle/lean hog spread is in for a multi-month or even a multi-year decline once the bull market finally ends.

Trade Reentry Strategy:

For tracking purposes, the blog will cancel the hypothetical trade to sell the April live cattle/lean hog spread. Place a new hypothetical order to sell one 40,000 lb. December live cattle contract and simultaneously buy one 40,000 lb. December lean hog contract if the spread rallies to 83.50 (premium cattle). Initially, the spread will be liquidated on a two-consecutive day close above 90.00.

Cattle Crush Spread: Exit Strategy Amendment

Cattle Crush Spread

The IMC blog is holding hypothetical long positions in the August-April-May 6:3:2 cattle crush spread. The initial position was entered at -$10,860 (premium the sum of the feeders and corn) On October 27th and an ‘add-on’ position was entered at -$350 (premium the sum of the feeders and corn) On February 23rd.

The first position was being risked to a two-consecutive day close below -$20,750 and the ‘add-on’ position was being risked to a two-consecutive day close below -$10k. But based on the current price action, we are going to amend the exit strategy.

Aug-April-May 2015 Cattle Crush spread daily

Aug-April-May 2015 Cattle Crush spread daily

The August-April-May 6:3:2 cattle crush spread did close below -$10k for two days, but we are going to give it a few more days of trade before exiting the ‘add-on’ position. The reasons for the change are four-fold:

First, the spread dropped for seven-consecutive days. This nearly matches the eight-consecutive day decline into the October 3rd low, which was followed by a complete recovery over the next several weeks.

Second, the seven-day decline knocked $14,362.50 off the August-April-May 6:3:2 cattle crush spread. This is remarkably similar to the $14,660 decline over the eight-day period into the October low, indicating that it may be very oversold here.

Third, in just over a month’s time the spread has retraced two-thirds of the four-month rally from the contract low to the February peak. Markets often reverse course after a retracement of either side of two-thirds of the preceding run. This phenomenon is exhibited by the adherence to the Fibonacci .618 (62%) retracement levels across many different asset classes on multiple timeframes.

Fourth, while this spread is in negative territory (the sum of the live cattle is discounted to the sum of the feeders and corn), the nearest-futures spread has the live cattle trading at a huge premium. This implies that the further out spread may be steeply underpriced.

Nearest-futures Cattle Crush spread monthly

Nearest-futures Cattle Crush spread monthly

While we have a set of trading and risk management criteria for the spreads, there are times when a market move requires some flexibility. This may just be one of those times, so we are going to keep a close eye on things for a few days and see how this plays out.

Cattle Crush Spread: The ‘Add-On’ Buy Criteria Was Triggered

Cattle Crush Spread

Yesterday the blog entered a hypothetical ‘add-on’ trade on the long side of the August-April-May 6:3:2 cattle crush spread. The position was entered at -$350 (premium the sum of the feeders and corn) by purchasing six 40,000 lb. August 2015 live cattle contracts at 139.125 (total value of $333,900), selling three 50,000 lb. April 2015 feeder contracts at 197.05 (total value of $295,575), and selling two 5,000 bushel May 2015 corn contracts at $3.86 3/4 (total value of $38,675).

This new ‘add-on’ position will be will be liquidated on a two-consecutive day close below -$10k ((premium the sum of the feeders and corn).

Also, we are still working another ‘add-on’ trade to enter a third August-April-May 6:3:2 cattle crush spread on a close above +$6k (premium live cattle). This next ‘add-on’ position will be liquidated on a two-consecutive day close $500 below the lowest closing price that follows the February 6th peak. Once we get this one, our plates will be pretty full. We will have tripled the original position size at that point so we will become laser focused on managing risk and trying to squeeze as much profit out of the trade as possible.

The Cattle Crush Spread: The Stampede Continues! Time To Buy More.

The Cattle Crush Spread

On October 27th the August-April-May 6:3:2 cattle crush spread closed above the declining 30-day Moving Average for the first time in over two months. This signaled a bullish trend change and the blog initiated a hypothetical long position.

The long position was entered at -$10,860 (premium the sum of the feeders and corn) by purchasing six 40,000 lb. August 2015 live cattle contracts at 153.60 (total value of $368,640), selling three 50,000 lb. April 2015 feeder contracts at 227.30 (total value of $340,950), and selling two 5,000 bushel May 2015 corn contracts at $3.85 1/2 (total value of $38,550).

The August-April-May 6:3:2 cattle crush has been trending higher since a multi-month low was established in early October. The live cattle finally traded at a premium over the feeders and corn in mid-January and a multi-month high of +$5,375 (premium cattle) was posted on February 6th.

Not Even Close

Technically, the trade we are doing here is a ‘reverse cattle crush’ where we are buying the end product (live cattle) and shorting the productions costs (feeders and corn). This is because the end product (live cattle) has been grossly underpriced by historic measures.

We looked at over four decades or price data to determine the parameters and discovered that the 6:3:2 cattle crush spread is usually nearing a bottom and providing a great buying opportunity when it trades under +$10k (premium live cattle). So even at this month’s new multi-month high of +$5,375 (premium cattle) the spread is still historically underpriced!

Aug-April-May Cattle Crush spread daily

Aug-April-May Cattle Crush spread daily

Remember that prior drops below the +$10k (premium live cattle) level have ultimately been followed by rallies back up in the +$20k to +$30k zone. We are nowhere in the neighborhood of this area yet. This indicates that the spread still has tremendous upside potential from here. To take advantage of it, aggressive spread traders could add to positions as the trade continues to accrue open profits.

Trade Strategy:

Thanks to the recent $5k pullback, we have two ‘add-on’ set ups for aggressive spread traders. For tracking purposes, the IMC blog will make the following two ‘add-on’ trades:

First, buy six 40,000 lb. August 2015 live cattle contracts and simultaneously short three 50,000 lb. April 2015 feeder contracts and short two 5,000 bushel May 2015 corn contracts at +$1k (premium live cattle) or better. This position will be liquidated on a two-consecutive day close below -$10k ((premium the sum of the feeders and corn).

Second, buy six 40,000 lb. August 2015 live cattle contracts and simultaneously short three 50,000 lb. April 2015 feeder contracts and short two 5,000 bushel May 2015 corn contracts on a close above +$6k (premium live cattle). This position will be liquidated on a two-consecutive day close $500 below the lowest closing price that follows the February 6th peak. In other words, we are risking a two-day break below the correction low that precedes a breakout to new contract highs.

Live Cattle/Lean Hog Spread: An Exit Signal and Some Reentry Parameters

Live Cattle/Lean Hog Spread

On December 17th the IMC blog made a hypothetical trade by selling one 40,000 lb. February live cattle contract at approximately 155.82 and simultaneously buying one 40,000 lb. February lean hog contract at approximately 80.47. This opened a short spread position at 75.35.

The exit strategy was to liquidate the February live cattle/lean hog spread on a two-consecutive day close above 82.42. These parameters were triggered on December 30th when the spread closed at 83.52. This resulted in a hypothetical loss of -$3,268 on the trade.

February Live Cattle Lean Hog spread daily

February Live Cattle Lean Hog spread daily

Since it will be February in just a month, it may be prudent to look at the further out April spread in order to add a little more time to the spread for a reentry attempt. Last month the April live cattle/lean hog spread altered its bullish price structure when it traded below a prior month’s low for the first time since the mid-July correction low was established. It made a new contract high by the end of the month, creating an ‘outside bar’ with an upward reversal on the monthly timeframe. This makes the December low of 73.65 an important near-term support level. Therefore, a spread trader could use a break of the December low as a reentry signal on the short side. Since the blog is tracking the spreads with hypothetical trades, that’s exactly what we’ll do.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 40,000 lb. April live cattle contract and simultaneously buying one 40,000 lb. April lean hog contract if the spread closes below the December 17th low of 73.65. Initially, the spread will be liquidated on a two-consecutive day close of half a cent (50 pts.) above the contract high that precedes the entry (currently at 81.07).