Today I see a spread trade setting up. Vegetarians need not apply. For meat eaters chomping at the bit, I’m looking to go long live cattle; short lean hogs. But first, let’s take a look at the two commodity markets separately.
I think June live cattle have found support at $120.00. After trading lower by 8.6% in the last four months, prices bounced about 1.5% off yesterday’s lows and have hopped back over the 9-day MA, currently trading at 122.90. I’m targeting a 38.2% Fibonacci retracement which would lift June futures back above $125.00.
On the flip side, June lean hogs have rallied 5% in the last week – a move I don’t expect to be sustainable. I see limited upside in lean hogs as 92.00 has served as resistance the last five weeks.
Here’s a spread chart showing: Live Cattle / Lean Hogs.
Sizing a spread trade in commodities is easy when the two commodity products trade in contracts of equal size. Live cattle and lean hogs fit the bill, with each contract being for 40,000 lb. of meat. This allows us to trade the spread 1:1, with every 1-cent move in the spread equating to a $400 gain/loss.
Note: Let me be explicitly clear that trading spreads is no less risky than trading outright directional plays. In fact, they may be more aggressive as it’s possible to “be wrong” on both side of the trade.
Nonetheless, I’m expecting this spread to widen. Ideally, live cattle will trade higher and lean hogs lower… with both sides contributing to a widening spread. But if this doesn’t happen, we should still come out ahead if both contracts rally (as long as live cattle rallies MORE), or if both contracts trade lower (as long as live cattle falls LESS).
As you can see in the spread chart above, live cattle are trading at a 32-cent premium to lean hogs. Looking back about nine months, the widest the spread traded was 37.50-cents; the narrowest being 29-cents. With the current spread at 32-cents, we’re closer to the bottom of this range than the top. Again, I’m expecting the spread to widen and suggest trying to jump in and out of a quick trade. Let’s target 3- to 4-cents of spread expansion ($1,200 – $1,600 in potential profit) and cut our losses short (at 3-cents, or -$1,200) if the spread trades under 29-cents.
As always, I’m here to discuss specifics and give guidance. Give me a call…
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