2015 October Spread Update – A Good Test

The first around with the feeder cattle bear spread, things worked very quickly. That was great, but it is not normal. Many times we are reversing a trend with a spread so at least some drawdown is to be expected. Given the nature of this trading strategy, it is prudent to properly leverage so drawdowns are not an issue. In many cases, this can present an opportunity to cost average while the fundamentals are still holding up.

Futures Spreads Update

Please note that I am assuming you have a similar entry to myself. Adjust the figures based on your own entry, current excess equity, and risk tolerance.

Short Jan vs Long Mar Feeder Bear Spread

Proposed Entry: approximately 2.50
Proposed 2nd Entry: 4.25+ and the final one at 6.00+
Cut-off Date: Roll to the next applicable feeder intra spread

Feeders have corrected from the recent tumble with the heavy cattle being pushed through slaughter and rain hitting the southern wheat crop. While feedlots with cheap grain will be placing aggressively, look for demand to wane after the next 2-3 weeks. A 2nd entry at 4.25 is well within striking distance as the spread already broke the four dollar level before settling back down. Historically speaking, this spread has had a difficult time holding the $3 mark and often settles below $2.

Feeder bear spread

Feeder bear spread

Short 10-Year Treasury Note vs Long 5-Year Treasury Note

Proposed Entry: approximately -$8,000
Proposed 2nd Entry: -$10,000
Cut-off Date: Keep rolling the spread until a target profit is realized

The Fed is unlikely to raise interest rates in October. but Yellen has made it clear December is still very much in play. A core inflation of 2.0% along with other improving economic indicators will be enough, in my opinion, to give the green light for a quarter-point hike. From there, 2% by the end of next year is not out of the question. Keeping these points in mind, the note spread should be a long-term play. I’d personally aim to take at least $2,000 out of the position, minus fees.

Note futures spread

Note Spread

Long Dec KC Wheat vs Short Chicago Wheat

Proposed Entry: approximately -10 to -12
Proposed 2nd Entry: -30 and final one at -50
Cut-off Date: Avoid carrying the spread within a week of first notice (11/28)

While the current spread is pretty close to the proposed entry target, it is worth reiterating the timeline and 2nd entry target. There is about a month left for this spread to work its magic. Barring an exception from the historical pattern, a profit of approximately $1,000 is a reasonable goal. If this does happen to be the odd year out, look to exit about a week from first notice and consider a roll to March. The roll will likely not be as lucrative.

The fact still remains that KC Wheat is a premium grain when compared to Chicago Wheat. Regional disparities are really the only major factor that can keep this spread from not flipping sides.

KC vs Chicago wheat intermarket futures spread

KC vs Chicago wheat intermarket futures spread

Short Feb vs Long Dec Hog Bear Spread

Proposed Entry: approximately -2.50
Proposed 2nd Entry: 0.00 and +2.00
Cut-off Date: Look to exit mid-November regardless of unrealized gains/losses

Hogs made a corrective leap higher as they gapped upwards. This movement has brought the spread with it and brought into question the strategy. After digging deeper, there are no real changes to the fundamentals over the last week. If the spread hits 0, I’ll be adding another position with a final entry at 2.00. History has shown the spread has a hard time holding above zero with many years dipping several dollar lower. In the case the seasonal tendency doesn’t hold up, exit around the November 15-25 time frame. The seasonality ends at approximately that point.

Lean hog bear spread

Lean hog bear spread

Long March vs Short April Heating Oil Bull Spread

Proposed Entry: approximately 0.00
Proposed 2nd Entry: -$500
Cut-off Date: Avoid carrying the spread into February

The weather models are predicting a warm winter, but predicting the weather are often carries the same odds as flipping a coin. One source that I trust, Weather Trends 360, is showing a slightly cooler 2nd half to December in the Northeast region. The majority of heating oil is utilized in this region and may be just enough to perk interest in the March vs April spread. The gap between these two contracts has shown in the past to rise rapidly on weather news and taper on bearish fundamentals. It is currently above the proposed target of 0, but it is good to prepare for a 2nd entry while keeping your eyes on the exit target.

Heating oil bull spread

Heating oil bull spread

Summary 2015 October Spread Update

These spread trade ideas are a great way to invest in the futures market, but risk has to be at the forefront of your overall strategy. Don’t participate in these positions if your equity is too tight. The ability to add positions and withstand drawdowns is very important for a winning game plan. As always, feel free to contact me with your questions.

tyler@cybersprout.net

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