Feeders/Live Cattle Spread: The Short Sale Signal Was Triggered Today

Feeders/Live Cattle Spread

A lot has happened in the last eight days. Last week the October feeder/live cattle spread closed less than $100 away from the January 5th high of +$49,410, which is currently the high for 2015. Today it closed at a two-month low. Switching from a multi-month high to a multi-month low indicates that the tide has turned in favor of the bears.

Today’s close below price support at the May low of +$46,890 (premium feeders) triggered the hypothetical sell signal for the blog. A short position would have been initiated by selling one 50,000 lb. October feeder cattle at 212.075 (a contract value of $106,037.50) and simultaneously buying one 40,000 lb. October live cattle at 150.725 (a contract value of $60,290). This opens up a spread position at +$45,747.50 (premium feeders).

October Feeder Cattle Live Cattle spread daily

October Feeder Cattle Live Cattle spread daily

Initially, we will risk a two-day close above +$49,820. This is $500 above the June top.

As we’ve mentioned before, this spread has over $25k to go before it returns to a historically normal level. The October feeder/live cattle spread has a lot of profit potential on the downside. We will be watching to see how things unfold. If we’re lucky, a few countertrend rallies along the way may provide us with setups to add to the short position. We shall see.

Live Cattle/Lean Hog Spread: Short Sale Signal Triggered

Live Cattle/Lean Hog Spread

On Monday the December live cattle/lean hog spread closed at a new contract high of 95.12. Three days later, it closed at 91.85. This 3.27-cent pullback off the highs is the largest pullback that has occurred since the mid-April correction low was established. It also triggered the blog’s entry criteria to get short on a pullback of three cents (3.00 points) or more (on a closing-basis) from the watermark high.

The IMC blog made a hypothetical trade by selling one 40,000 lb. December live cattle contract at approximately 152.47 and simultaneously buying one 40,000 lb. December lean hog contract at approximately 60.62. This opens a short spread position at 91.85. Initially, we will liquidate the spread on a two-consecutive day close above 95.62 (.50 points above the contract high).

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

If the December live cattle/lean hog spread closes at a price of 92.85 or less today it will post the first weekly loss in nine weeks and alter the bullish price structure. This would corroborate the current overbalancing of price on the daily timeframe. After that happens, we will be pulling for a two-day close below the rising 20-day Moving Average (currently around 89.95) for the first time since the first half of May and a close back below the March 23rd top at 89.62 (old price resistance, once it has been broken, becomes new price support). Once this occurs, the bearish trend reversal in the December live cattle/lean hog spread should be solidified.

Trade Strategy:

The blog is still working a hypothetical ‘add-on’ 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 closes below 80.00 (premium cattle). Initially, risk the ‘add-on’ position to a two-day close above 85.00.

The price parameters for this ‘add-on’ trade could be changed if the price pattern between here and there lends itself to a better setup. We will certainly post an update if this turns out to be the case. It won’t be the only ‘add-on’ trade that we do, though. Since the 20-cent area is a historically normal level for the live cattle/lean hog spread to return to, we want to take full advantage of the bear market potential by actively looking for additional ‘add-on’ opportunities.

 

Feeder Cattle/Corn Spread: Updated Short Sale Parameters

Feeder Cattle/Corn Spread

The blog is working an order to short the August-September feeder/corn (x6) spread on a break of the May low. Recent price action gives us room to bump the entry level a bit higher. In addition, we are going to buy ourselves a little more time and switch from the August feeder contract to the October contract.

The mid-November bounce high of -$2,175 (premium corn) was a resistance level to watch in the October-September feeder/corn (x6) spread. This level was clipped on May 11th when the spread closed at -$1,725 and started to roll over. It looked like we had the potential for a double top up here.

A week and a half later, the spread blew past the May 11th top and didn’t pause until it reached +$3,100 (premium feeders) on June 1st. Therefore, the November 19th and May 11th highs turned into a price support level.

October Feeders September Corn (x6) spread daily

October Feeders September Corn (x6) spread daily

The October-September feeder/corn (x6) spread then retreated from the June 1st high, bottoming out at -$1,975 on June 8th. This was right at the price support zone between the November 19th and May 11th highs of -$2,175 and -$1,725, respectively. From there, the spread recovered quickly. It is now right back on the doorstep of the June 1st high.

So now we have a line of defense at the November 19th high of -$2,175, the May 11th high of -$1,725, and the June 8th pullback low of -$1,975. A breach of this support could indicate that the run is over. Therefore, we have good reason to bump the entry price up to a break below this support zone.

In terms of the ratio between the value of one 50,000 lb. October feeder cattle contract and one 5,000 bushel September corn contract, the November 19th high was 5.89:1, the May 11th high was 5.91:1, and the June 8th pullback low was 5.89:1. At nearly six-to-one, this is why we are spreading six corn contracts against on feeder contract. It helps to normalize the position.

Feeder Cattle Corn ratio monthly

Feeder Cattle Corn ratio monthly

In the last four decades, only 2005, 2014, and this year saw the nearest-futures feeder/corn ratio hit 6:1 or higher. Historically, the ratio does not go above 4:1 or below 2:1 very often. Whenever that has happened, the ratio has eventually reversed and gone back to either side of 3:1. Therefore, we can say that the current ratio is about double what it should be. A break of Monday’s pullback low in the spread and the ratio could potentially be the crack that’s needed to break the whole dam open.

Trade Strategy:

Cancel the hypothetical order to short the August-September feeder/corn (x6) spread on a break of the May low. We will work a new hypothetical order to sell one 50,000 lb. October feeder cattle contract and simultaneously buy six 5,000 bushel September corn contracts if the spread closes below -$2,200 (premium corn). Initially, the spread will be liquidated on a two-consecutive day close $500 above the multi-month rally high that precedes the entry (currently at +$3,100).

Feeders/Live Cattle Spread: Let’s Short the Halloween Spread If/When the Bulls Get Spooked!

Feeders/Live Cattle Spread

October Feeder Cattle Live Cattle spread daily

October Feeder Cattle Live Cattle spread daily

This morning the October feeder/live cattle spread traded less than $200 away from the January 5th high, which marks the current high for 2015. The spread has now clipped slightly above the Fibonacci .618 retracement of the entire decline from the mid-November contract high to the late February contract low. This would be a good place for a secondary top to form. Therefore, we are going to get our parameters in place to get short if the spread does reverse from here.

Feeder Cattle Live Cattle spread monthly

Feeder Cattle Live Cattle spread monthly

If we’re really lucky, the spread will continue to run higher and try to return to the contract high of +$53,720 before it turns lower. This would give us an opportunity to get short at an even higher level after a double top or a Wash & Rinse (failed breakout) pattern occurs. But since we don’t know where the top is or when the reversal will happen, it makes sense to go ahead and have a plan in place.

Feeder Cattle Live Cattle ratio monthly

Feeder Cattle Live Cattle ratio monthly

The surge over the last two and a half years has taken the feeder/live cattle spread to record highs. History shows that this spread is normally priced at less than half of the current levels. The current ratio of 1.8:1 in the October contracts is just off the record high as well. By both measures, feeders are way too expensive in comparison to cattle. Over the last several decades, the ratio has always reversed and gone back down to 1.3:1 or lower after reaching 1.6:1 or higher. Therefore, the short side of the feeder/live cattle spread is where informed spread traders should be focusing their efforts.

Trade Strategy:

The blog will work a hypothetical order to sell one 50,000 lb. October feeder cattle contract and simultaneously buy one 40,000 lb. October live cattle contract on a close below the May low of +$46,890 (premium feeders). Initially, the spread will be liquidated on a two-consecutive day close $500 above the watermark high of this rally that precedes the entry.

Live Cattle/Lean Hog Spread: The New Trade Setup

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 and liquidated it at 85.75 (premium cattle) on May 28th for a hypothetical loss of $900. The position was liquidated early because of an upside breakout of a multi-week trading range. It seemed that the odds favored more upside, so it did not make sense to continue to hold the short position. Our plan was to get out and look for a setup to reenter after a run higher.

Just in case we got caught flat-footed and the spread collapsed right after we exited, we left the ‘add-on’ short sale order in place to sell on a break below the April correction low. That way, we would not have to worry about missing out if the bear market started.

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

As it turns out, covering the short position was the right thing to do. The December live cattle/lean hog spread rallied to a two and a half month high of 89.20 today, putting it just a stone’s throw from the March 23rd contract high of 89.62. This would be the perfect place for the spread to roll over and establish a double top. Better yet, it would be nice to see a Wash & Rinse sell signal where the spread pushes beyond the March high and then flips over. A failed breakout could be a more powerful sell signal than a classic double top since it would trap the buyers in on the wrong side of the market before the sell-off.

Furthermore, the ratio between December live cattle and December lean hogs firmed to 2.34:1 today. This brought it to the Fibonacci .618 retracement of the entire decline from the March contract high to the May multi-month correction low. This would certainly be a good technical level for the ratio to peter out.

December Live Cattle Lean Hog ratio daily

December Live Cattle Lean Hog ratio daily

Although the current levels would be ideal for the spread and the ratio to reverse, we have no idea if they actually will. Alas, we are currently out of batteries for our crystal ball (we’ve already ordered new ones on Ebay, as well as a new Flux capacitor for the DeLorean) and we’ve no confidence in the Magic 8-ball sitting on the trading desk. Therefore, we are going to have to rely on the old-school methods of the legendary trend followers and wait for a reversal before jumping back in.

Trend Change Signals

On the daily timeframe, the two largest pullbacks that the December live cattle/lean hog spread has experienced during this run from the mid-April low were approximately two cents (2.03 pts and 1.93 pts, respectively). Therefore, a pullback of three cents or more would be what is referred to as an ‘overbalancing of price’. Once that happens, the correction pattern on the daily chart is turned into a trend reversal pattern.

Also on the daily timeframe, the spread has closed above the rising 20-day Moving Average every single day for nearly a month. (Three more days will make it exactly one month). Therefore, a close below the 20-day MA (currently around 85.02) for the first time since May 12th would signal a potential trend change as well.

On the weekly timeframe, the December live cattle/lean hog spread has posted weekly gains for five consecutive weeks. Therefore, a weekly loss would alter this pattern and potentially signal a trend change.

Our strategy is to use one of these pattern changes to reenter a short position and use a break of the April low to double the position size. If the cattle/hog spread continues to fall from there we will look to continue adding to the short position to take full advantage of it.

Trade Strategy:

The blog will work a 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 posts a weekly loss or makes a pullback of three cents (3.00 points) or more (on a closing-basis) from the watermark high, whichever occurs first. If filled, risk a two-day close .50 points above the contract high that precedes the entry.

Also, continue to work a hypothetical ‘add-on’ 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 closes below 80.00 (premium cattle). If filled, risk the ‘add-on’ position to a two-day close above 85.00.

Feeders/Live Cattle Spread: Don’t Get Trampled In This Stampede!

Feeders/Live Cattle Spread

Since December 12th, the IMC blog has been holding a short position in the feeder/live cattle spread. After rolling over, the spread is currently short from the equivalent of approximately +$50,415 (premium feeder contract value) in the August contracts. (Note that we are looking at the difference between the values of the two contracts instead of the market prices. This will make it easier to track the P&L on the trade).

After the huge decline from the October peak to the late February multi-month low, the August feeder/live cattle spread rallied for a month and retraced to the midpoint of the decline. Nearly a month later, it had rolled over again and retraced more than half of the bounce. This should have put the spread on course for a break well below the February bottom.

August Feeder Cattle Live Cattle spread daily

August Feeder Cattle Live Cattle spread daily

Instead, livestock sector firmed from the April correction lows and stampeded higher. This sent the August feeder/live cattle spread running north as well. Yesterday’s close above the March peak was bullish and the spread has gone even higher today, putting the short position in the red for the first time since early January…and you know how things turn out when bulls see red! It currently does not pay to be holding a short position. We don’t want to “mess with the bull and get the horns” so let’s just exit stage right.

The position liquidation is just temporary. Spread traders should be prepared to jump back in once price complies.

October Feeder Cattle Live Cattle spread daily

October Feeder Cattle Live Cattle spread daily

Since we’re soon moving into the summer months, we will start watching the further out October spread instead of the August spread. It’s right on the doorstep of the current 2015 high that was posted on January 5th and it has recovered nearly two-thirds of the October-February decline. It certainly wouldn’t hurt our feelings to see the October feeder/live cattle spread score new 2015 highs and return to the November 18th contract high of +$53,720 (premium feeders) before it rolls over again.

Ridiculously Expensive

Remember that the difference between the value of a 50,000 lbs. of feeder cattle contract and a 40,000 lbs. of live cattle contract has historically been considered expensive when it reached a premium of +$15k! The explosive move higher over the last couple of years is unprecedented as the spread has rocketed into uncharted territory.

Feeder Cattle Live Cattle ratio weekly

Feeder Cattle Live Cattle ratio weekly

Using the ratio to normalize things reinforces this view that feeders are way too pricey in comparison to live cattle. The ratio between the October contracts touched a new high for 2015 this month when it closed at 1.8:1.   On the weekly nearest-futures chart, last year is the first time in history that the ratio has ever reached 1.8:1. Historically, it is considered ‘expensive’ once it reaches 1.6:1. The October ratio has never even been as low as 1.6:1 yet! Therefore, we know that the spread and the ratio remain at unsustainable levels. History shows that the ratio has always gone back down to 1.3:1 or lower after reaching 1.6:1 or higher. This is exactly why spread traders had better keep a close eye on the October feeder/live cattle spread. A new short sale signal is a high-probability trade that could offer some homerun returns.

Trade Strategy:

Buy back the one short 50,000 lb. August feeder cattle contract and simultaneously sell the one long 40,000 lb. August live cattle contract at +$51,000 (premium feeders) or better. Cancel any outstanding ‘add-on’ orders.

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.