July 27, 2014
Fact: 20, 30 and 40 percent sell offs are a routine occurrence in the futures markets.
I think, minimally, a 25-30% break in Feeder Cattle is dead in front of us.
A 25% decline would take this market down 55 cents, or $27, 250 per futures contract.
The bullish move during the past 15 months absolutely dwarfs the action for the preceding 40 years…but if you look closely, and do a little math, you should be able to note COUNTLESS 20%+ swings, up and down, throughout those 4 decades…and I assure you this tendency has NOT changed. If anything, in this day and time, with massive amounts of money banging from screen to screen and market to market, volatility has only increased…and I have zero doubt a 25% break IS just as possible in 2014 as it has been everywhere else on this chart…
It is always the same story…
Do you remember how a few years back ALL the analysts and brokerage houses were SO bullish $8.00 Corn, $9.00 Wheat and $18.00 Soybeans? How supplies were supposedly SO tight, and demand so strong, that we might run out of product to fill the pipelines? Or how absolutely DEVASTATED the Wheat crop was out in Kansas? I even remember talk of “no wheat crop” at all…and according to the overwhelming majority of the “expert” ag opinions out there, you’d have thought all three markets would stay up forever…
But they didn’t. In fact, they have all fairly collapsed, but this should really be no surprise at all…They’ve done so right in line with my statement that 20,30 & 40% sell offs ARE routine in the futures markets.
If you’re in agriculture, you already know this…but take at look at the real numbers…
So I am going to ask you…Why should the cattle market be any different? If you are a cattleman and you don’t think the same thing can happen in Feeders and Live Cattle that has happened in the grains, I’d suggest you are dangerously kidding yourself.
If you are in the cattle business, I think you should be preparing for an EXTENDED period of sharply lower prices…because…it’s just the way the market works. I don’t care how many times you see stats about “lowest numbers in 50 years”. The next few years will probably be painful…especially if you have been a buyer at current levels…and I think the risks are especially high over the next 6-9 months. This market WILL stop on the upside (and may already have done so) and the trip down will most likely be BRUTAL.
In my opinion, This WILL happen…and with prices now at seriously jaw dropping record levels, I think the time is now. Obviously, I may be quite wrong but to me, the only real question is how much and for how long will they go down.
And just to further substantiate my 20,30, 40% comment, here are a few other examples from recent years…
How about Cotton a few years ago…which, in many ways, resembles today’s Feeder Cattle market in that Cotton’s old historical highs were around the $1.00 mark (same as Feeders), then prices more than doubled in roughly a year (same as Feeders)…which was then followed by a massive collapse…
And how about these other recent bull markets that were followed by the same high percentage declines…And I emphasize, there were ALL accompanied by rampant bullish fundamental “logic” at their highs…
Here’s another one reminiscent of Feeders…Where it doubled in price in a relatively short period of time…then collapsed.
And finally, here are a few examples from Feeder Cattle in recent years…And do note that neither of these tops occurred from anything even close to the extreme we currently have in this market..
The point is…IT’S GOING TO HAPPEN…No, I can’t sit here and write, “I KNOW for a fact it will happen”, but I can say I think the odds of SOME degree of a large percentage sell off are about as high as they ever get.
At the highs, NOBODY can EVER imagine the market 40-50% lower…but it happens over, and over, and over in this business…pretty much in every market we trade…And it NEVER EVER gets started when there is ANY reason to expect it…So do NOT think you are going to come up with some logical set of criteria that tell you the time is now…or later. As I am forever repeating, NO prices are real in the futures market. This is a giant mob psychology game played with real money and a lot of leverage. When a bull market stops, it just STOPS. That top tick has nothing to do with rationality. All the shorts have given up. Everybody else thinks, “I know it will stop somewhere but it sure as hell doesn’t look like it right now”. BUT IT DOES.
So that’s the set up. I think Feeders are a massive sale. The next question is, “How do you do it?”, and no, it’s not easy. It’s not a snap. And it’s not cheap…But the trade CAN be made successfully…and here are what I would say are some guidelines as to how you go about it.
How to Short Feeder Cattle
My oldest, and actually very first client, going all the back to 1980, had a great comment about shorting this market: “ I want to get me some of that money. It’s out there on the table. How do we get it?”…And that’s really what this is about…Everybody knows cattle can’t stay up here. That’s easy…The big question is: How DO you get some of that money?
Start with this: Again…Do NOT think you are going to figure out the best time to do this. Do NOT think you are going to be able say, “I KNOW the top is here”, or “I KNOW the top will be at $____”. You can’t do it. All you can do is make the decision that $2.20a pound is good enough (see the long term chart), figure out which options you want to buy, and put your money on the table…And then, be ready to do it again, with more cash, if some time goes by and it becomes necessary (or desirable) to make another move…What you CAN’T do is spend the money, lose it if the market doesn’t go down and then walk away…or lose it and think, “It’s not ready yet. I’m going to watch it a while”. When you’re in, you stay in. You commit to the idea it WILL go down…as when it does start down, it should be going down a LOT, and when (if) it does, your targeted return should be MANY multiples of what you spent on the position…Obviously, if none of this happens as I anticipate, you can also lose everything you have on the table…but this is a risk I am willing to take.
So what options do you buy? What strategy do you use?
Here is the simplest way I can put it:
PAY UP AND BUY A LOT OF TIME. Go out to next January, March, April and/or May.
PAY UP AND BUY AT-THE-MONEY PUTS. Or slightly out-of-the-money’s. They can be bought for 6-7 cents. A 20% sell off would take Feeders down about 40 cents. Do the math. 7 becomes 40?
FORGET YOU OWN THE POSITION. If it starts going down, let it go down. Don’t starting thinking about where you want to get out. The worst thing you can do is start forming short term opinion, as in, “It dropped 9 cents last week. Maybe I should get out and wait for a bounce and get back in”. The game plan is to look for AT LEAST a 20% decline before you even think about taking money out of the market.
IF IT IS STILL “UP” SEVERAL MONTHS LATER, AND YOU ARE LOSING MONEY, COMMON SENSE (MINE, ANYWAY) ARGUES THE ODDS HAVE GONE HIGHER THE BREAK HAS BECOME MORE IMMINENT…AND POTENTIALLY BIGGER…AND YOU SPEND MORE MONEY. YOU ADD TO THE POSITION. No, you don’t go nuts and go mortgage your house or anything. Taking measured financial steps is important here, so you should start with what is a reasonable amount of money for you to risk, and be happy with what profits can potentially be made if this works…but be ready (and able) to buy more time or higher strike prices if the market either stays here a few months…or moves substantially higher….For example, if you own 212 puts and the market jumps up to 230, even though there is still an excellent chance those 212’s will eventually be profitable, it would only make sense to add some 225 puts, with even more time, to whatever options you already own…IN OTHER WORDS, YOU COMMIT TO STAYING SHORT AND MAKE SURE YOU ARE IN A POSITION TO BACK IT UP FINANCIALLY. What you DON’T do is short it here, then watch it scream some more on the upside…and then let the market (and accompanying news) convince you that “It’s probably going even higher!”
Quite honestly, the hard part will be letting it happen when it does start dropping. The hard part will be when it hits 1.90 and you have a nice gain…and you start worrying about it going back up and “giving back the profit”…instead of just letting it continue to happen…which is why I throw that line out there, “Forget you own the position”. There will be weeks or months when it goes sideways, or the wrong way, or when you find yourself getting impatient and worrying about it seriously rallying again…but the best thing you can do is just sit, almost ignore it…and it WILL (I believe) end up like all those declining market examples I presented above.
I CERTAINLY DON’T KNOW HOW THIS WILL PLAY OUT ONCE THE MOVE DOWN BEGINS BUT I DO BELIEVE THERE IS NO WAY FEEDERS WILL STAY AT CURRENT LEVELS, AND BEYOND THAT, I BELIEVE THERE IS NO WAY THEY WILL DEFY COMMODITY HISTORY AND EXPERIENCE SOMETHING LIKE A RELATIVELY TINY 10% DROP. AS NOTED BEFORE, I HAVE SEEN THIS SAME SCENARIO TOO MANY TIMES, IN TOO MANY MARKETS (LIKE ALL OF THEM) TO EXPECT ANYTHING LESS THAN A 25% SELL OFF.
There are various ways to do this…Here are a few options, approaches and strategies…
All costs shown for these positions include all fees and commissions.
Absolutely the smartest way…the 2 & 1…Certainly the most expensive but the best way to go…It decreases the leverage but if the market continues to rally it gives you the possibility of being able to position again with 100% of your capital a higher levels.
Or just buy puts…But be ready to spend more money if the market goes sideways for months…or higher. In a sense, I see this as a waiting game. There may be no wait at all…or we might be sitting at 230-240 a month from now, and you HAVE to be prepared to follow the game plan.
Here’s 3 more months of time for a few cents more…
And here’s an idea that is extremely interesting…based on the idea Feeders are NOT going to just quietly sit here for the next 119 days…that they are either going to keep screaming on the upside, or get racked on the downside…And this position actually puts you in a position to potentially make money either way it goes…AND STILL BE POSITIONED FOR THE SELL OFF WHENEVER IT FINALLY DOES MATERIALIZE.
As I’ve often commented, writing this newsletters helps me to crystallize my thoughts, and I often “stumble” into perceptions as I sit at this keyboard and try to help you clearly understand what I see…And while every approach outlined above has merit, this 1&1 may be the best of all of them…If the market does keep rocketing higher, you have the opportunity to make money AND still be re-positioning for the “big one” on the downside at higher and higher prices…OR, if it DOES stop here, the potential percentage gains ARE extremely attractive (a 15% decline would be about a triple)…Obviously, the only thing that kills you is if this market just goes dead quiet for the next 4 months, and doesn’t go anywhere…But, for me, that is the easiest guess to make, and to that I say, “NO WAY it goes sideways”. And beyond, that, even if does flatline until the very end of November, this would only mean it is 4 months later and this thing is STILL in the stratosphere and STILL A MAJOR SALE.
This same approach can be used for any of the further out contract months as well…for example, using comparable 1 & 1’s in January for, actually, about the same 10 cents.
What I have to EMPHASIZE is, IF this market is still “up” 4-5-6 months from now, in my two cent opinion, it will be an even bigger sale. All markets go up and down. All markets are subject to high prices killing demand and “surprise” increases in unanticipated supply…And when they finally “die”, all futures markets do have a tendency to fail in somewhat spectacular fashion. This is the futures arena. This is high leverage. BIG PERCENTAGE MOVES ARE COMMON.
I think this sort of trade only comes along every 2 or 3 years…While it does not mean I will be successful here, this may be one of those rare moments that, having seen this situation so many times the past 34 years, being an “old hand” in this business may serve me well. I do see this as a monster opportunity but I also recognize that roaring bulls, and picking tops in them, can be about as nerve racking and unpredictable as it ever gets…So, I am not in this with the idea I KNOW this is where you sell it. I think IS where you go short or I wouldn’t be making this recommendation, but I also KNOW this thing could go to $2.50, or any number you want to dream up…but I also KNOW it ends somewhere…and when it does, the payoff can be big. BUT, you have to be there when it does stop and you have to be sure you don’t get “run out” psychologically…or simply run out of money.
Give me a call if you want to look at possibilities, or just to say hello. You know me. I always enjoy talking to all of you.
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Feeder Cattle