June 2, 2021
A Futures Trade
Buy Cattle – Sell Hogs
Since “the beginning of time,” Beef has been more expensive than Pork. Aside from the fact that nobody is going to pay the same thing for a pork chop as they would for a ribeye, what really matters is that you can breed a sow, and in maybe a year’s time have TEN full grown market ready 200 pound hogs…AND you can breed that sow twice a year…But with Cattle? It takes about 3 years just to do the same with one mama cow…to breed her, and then…3 years later…you get ONE slaughter ready steer. No longwinded explanation here: Cattle have been, and always will be, more expensive than Hogs.
However, there are times when the markets just get totally out of whack, wherein long standing relationships between commodities get turned EXTREMELY upside down…which can represent “extreme” opportunities if you bet on a return to what has forever been the NORM…And that is exactly what we have now in Cattle and Hogs.
To be precise, the Hog market recently has been screaming higher (the reason relates to swine flu having decimated the Chinese hog herd in recent years), having gone up about 40 cents a pound since January…while the Cattle market has essentially been dead sideways during the same timeframe…the result being that yesterday, August Hogs actually reached a point where they were more expensive than August Cattle. (!!!!)
The Lean Hog contract has been trading since 2002…and in a nutshell, what we saw yesterday has not even come close to happening during these past 19 years…and per the historical charts below, I firmly believe we have reached the “extreme of extremes,” and have little doubt that during the next few months, we WILL see Cattle become decidedly more expensive than Hogs…that we WILL revert to the “norm” that you see on the 19 charts following.
What follows are Spread Charts of every August Live Cattle vs August Lean Hog contract since 2002…
What you are seeing here is the price difference, in cents, between the two markets…and yes, you will note that 100% of the time, Cattle prices have been higher than Hog prices…and THAT is the norm.
The lowest difference at expiration was 9 cents…once, 17 years ago…With a couple of 10 cent closes…and then everything else was in the teens…and above.
And the average closing difference for the past 19 year is 27 cents…that is, August Live Cattle being 27 cents higher than August Hogs.
And do note that this spread can move in big, non-stop chunks…where it doesn’t matter what Cattle and Hogs are doing individually, but the spread just keeps going…
So…Here’s what the current spread looks like…Compare this to all those histories…
Here’s the longer term picture…
Here’s how you do it…This is a futures trade, meaning you do have unlimited risk. Margin for the spread is $3800…My recommendation is to Buy the Spread (Buy August Cattle-Sell August Hogs) and risk a close into new lows...or about $1600. If it DOES close into new lows, you exit and wait for one higher close again...And put it back on…MECHANICALLY AND WITHOUT HESITATION…And if you get it off successfully, whether on the first try or thereafter, I think you hold it until expiration.
And here is what the individual Cattle and Hog contracts look like…
If you think this makes sense, but the concept of “buying the spread” is confusing, give me a call…I’m sure I can easily make it understandable.
And yeah, you CAN just buy calls in Cattle, and puts in Hogs…but it’s not really the same thing as buying the spread.
A great trade. The historicals don’t lie. There’s nothing that says this HAS to work…but I like the odds. A lot.
All option prices in this newsletter include all fees and commissions. All charts, unless otherwise noted, are by Aspen Graphics and CRB.
The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Cattle, Hogs