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Robert Edwards
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Contrarian daytrading technician who specializes in locating high probability short term trades while predicting price movement directions with over 85% accuracy. Most of my trading involves either extremely short term micro scalping of stocks or commodities (using 1 minute bar charts), or swing... More
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  • Is The December Lean Hog Price Selloff Overdone And How Can I Use Options To Benefit

    The Background

    In this article I am going to explain an option strategy that I plan to employ this year, involving the sale of far out-of-the-money October and December Lean Hog puts, wherein I hope to capture the premium if the options expire worthless as I expect that they will. The odds are overwhelmingly in my favor. You may not care a "hoot", or should I say an "oink" about the swine industry, but the strategy that I am presenting can be applied to many other markets. We can begin by looking at the monthly price chart:

    You will notice that in 2014, lean hog prices made all time highs as the PED virus drastically reduced piglet numbers. Farmers quickly learned to cope with the outbreak and the reduction in pork supply for the year was in the single digits. In fact, instead of returning to the prices we were at in 2013, it is estimated that we will have about 6 to 8% more pork slaughtered in 2015 than we had in 2013. Most of the surplus should occur in the last half of 2015.

    The above monthly chart is only current through the end of May 2015. We have nearly completed the month of June 2015 and have fallen about $10 so far this month, from the mid $80s to the mid $70s. Pork prices are quoted per 100 weight (100 lbs) so if hogs were selling for 80 cents, it would be quoted as $80 per 100 weight. Recently the retail price of pork was selling for about $3.90, so to have "the board" (futures prices) trading in the mid $70s is kinda sad. Farmers get something less than the futures price, and the difference between the futures price and what farmers are paid, is called "the basis". Farmers typically receive 10 to 15 cents per pound less than the futures board price. Fortunately costs in 2015 have come down thanks to cheap soybean meal prices, and instead of needing the high $50s per 100 weight to break even, efficient farmers only need the low $50s. It will be a struggle to make money this year as farmers will earn no more than $8 per head, and many will lose money.

    Since 2014 is an outlier year, it is better to compare 2015 hog prices to what occurred in 2013. It is looking like farmers have been more aggressive than expected in expanding herds since the gestation period for a sow is only 114 days, a week shy of 4 months. That compares to gestation of a cow being 9 months. From birth to 225 lb. slaughter weight, takes 6 months for pigs. Slaughter cattle take 18 months. Thus pig numbers can drastically increase or decrease in a very short period of time, making for wide swings and volatility in prices when compared to beef prices. Not only supply, but demand also plays a factor and that too can see rapid changes up or down, depending on how many hogs are going to China or Mexico. Canadian imports used to be a problem in depressing pork prices but with so many hogs now going to China, a few pigs coming in from Canada is no longer a concern.

    Looking at the monthly chart, you will notice that in 2013, there was a March low of $76.80 in the nearby April Lean Hogs contract but otherwise we stayed above $80 for the rest of the year. In 2012 there was a dip to just below $70 in the August/September period, but by December we were again trading above $80. In 2011, we also stayed above $80. The last time we saw pork prices hit $50 or lower, was August 2009, as we were pulling ourselves out of the financial crisis. Because the Chinese now own the largest pork slaughter house (Smithfield Foods) and have drastically increases their import of US pork as a result, I don't ever see pork prices again trading under $60, and only rarely should they see $70s per hundred weight. Future pork prices should stay at the $80 or higher level a majority of the time.

    In 2015, just like 2013, a low was struck in March. In 2013, the low was $76.80, and in 2015, the low was $57.77. The 2015 yearly low was $21 lower than the 2013 low. After a summer rally, in 2013, Lean Hog prices fell towards the mid $80s, with a spike low hit at $80.22 in December. If we subtract a similar $21 from the December 2013 low, to calculate a projected December 2015 low, you would get $59 as your worst case scenario price for December hogs.

    By the way, I found a chart of price predictions for August 2013 through December 2013, click here, that was made in April 2013. At that time they thought December hog prices would be around $78.29 but in fact they never got below $80 and spent most of the time near the mid $80s, as shown on the above chart. I won't bore you with the references but I have studied price forecasting for pork and pork prices typically run $2 to $4 higher than predictions made a couple quarters early.

    My Lean Hogs Futures Trading Strategy Explained

    I am most interested in where the December 2015 price level will be as as I have a large trade that I want to put on the next few weeks. If we are running 5 to 10% more hogs now than in 2013, should the prices in 2015, be more than 5 to 10% lower than in 2013? Probably not. However, markets tend to overshoot on the upside and on the downside and the March 2015 low was $21 lower than the March 2013 low. That is a drop of 27%. No wonder we snapped back up about $28 off the low by the end of May 2015. Well, we have since given back about $10 of that rally, with July Lean Hogs closing at $75.75 on Friday, June 19, 2015.

    Knowing that prices in December should be running much lower than this summer, December 2015 lean hogs closed Friday at $61.65, a discount of $14.10 to the price of the July contract. If you remember my earlier calculation, the worst case scenario low for December 2015 Lean Hogs should be no lower than $59, with most trading occurring at least $5 to $6 higher than that, around the mid $60s. Thus the current $61.65 price has pretty well factored in all the bearishness that we need to deal with. Any moves below $59 would be way overdone, especially since we are talking about prices nearly 6 months out. Take a look at the daily chart of December Lean Hogs:

    In the last 2 1/2 weeks, December Lean Hogs have fallen $9. Anyone who would have shorted Lean Hogs above $70 and then bought back in the $61s on Friday, could have done so with a couple thousand dollars of margin, and earned $400 for every dollar drop, or $3,600. Not a bad trade at all for 2 1/2 weeks of work. However, now we could be in for a small bounce.

    If you look at the little 2 day bounce of Tuesday and Wednesday this past week and then drop back down on Thursday and Friday. week, it appears to be quite similar to what we saw in the middle of March, at about the same price levels. It appears we are showing some buying interest in the $61s back in March and at present. This looks like an excellent time to try and pick a bottom as the market already bounced earlier this past week.

    My Short Dec Lean Hog $50 Strike Put Option Trading Strategy Proposal

    Now what I could do is just go and buy December 2015 Lean Hog futures on Monday, and I probably will do so. However, I want to set up a very long term trade involving the sale of far out-of-the-money puts. With December 2015 Lean Hogs contract closing Friday at $61.65 the $50 strike put ($11.65 out of the money) is worth .875 ($350). I can sell this put and collect the premium that will immediately be added to my account. If December Lean Hogs expires at $50 or higher, then I can keep the entire $350 less commissions ($6). If Lean Hogs prices continue to fall, I can sell more puts at higher and higher premiums to lower my breakeven price. To lose money on this trade, December Lean Hogs would have to be trading below $49.125. If it does trade below $50, then the option will be in the money and I could get exercised and forced to buy and be long a $50 December Lean Hog Contract. Well, it sure beats buying at $61.65. How could I not find a way to make money on that contract?!

    There are lots of strategies that one can employ that begins with selling of a far out-of-the-money put. On a decent rally, I could always sell a far out-of-the-money call to balance out the position. That would then be called a short strangle position, one of my favorites.

    On Friday, 212 of the $50 strike December puts traded, showing great liquidity. While the $50 strike put trades at .875, the $52 strike put closed at $1.175 which is 20 cents higher. If Lean Hogs would fall another $2 lower on Monday, the $50 strike would increase just 20 cents, which means I would be temporarily losing $80 on margin when marked to the market. If a $2 drop in Lean Hogs causes a 20 cent increase in the $50 put, it is trading at a delta of .10 (10%). Selling a put is like being long 1/10th of a Lean Hog contract. Thus I could sell 10 of these puts to be required to put up margin for just one lean hog contract.

    Managing The Option Trade

    If December Lean Hogs dropped $6 right away next week, the .875 premium of the $50 strike put, would increase to $2.15, causing me a temporary loss of $1.275 or $510. The delta would increase to .35, so I would be long an equivalent of .35 or about 1/3 of a full contract. Earlier I said a full margin was $2,000 as that is how I think of it in my head. It is exactly $1320 on the first day and $1200 maintenance margin after that. After the first day one would still only need to have $510 plus $400 or $910 to hold one put if Lean Hogs dropped $6 early next week. With that drop the futures contract would still be trading $5.65 out of the money but the time value premium would have been increased and probability of being exercised in the money will have also gone up. Once a trade is placed there are lots of ways to manage the trade. I could catch a nice rally and then sell a far out-of-the-money call to balance the position, what is then called a short strangle position. You would be hoping that Lean Hogs goes off above your put strike but below your call strike. Short strangles is one of my favorite option trading strategies. You can also purchase calls or puts to create a spread or even involve futures contracts to balance out your position. The possibilities are endless.

    To see me place this trade and manage it on a daily basis, join us in our private Short Bull Trading Room on WeChat. Just download the free app on your phone or tablet, and then add "bobed1". You can then send me a message so I can invite you into the room. Still plenty of room.

    Last Saturday I sent out my third issue of my free weekly newsletter. Send an email to shortbull2020@yahoo.com if interested in subscribing. It is free!

    Disclaimer:

    The thoughts and opinions in this article, along with all STOCKTALK posts made by Robert Edwards, are my own. I am merely giving my interpretation of market moves as I see them. I am sharing what I am doing in my own trading. Sometimes I am correct, while other times I am wrong. They are not trading recommendations, but just another opinion that one may consider as one does their own due diligence.

    Jun 21 1:50 PM | Link | Comment!
  • We Should Know Soon If The 2015 Natural Gas Market Is Going Higher Like 2012, Or Going To Roll Over Like 2009

    The Setup

    I have always been quite impressed with articles that I read from Main Street Trading as they almost always align with the way I see the markets. However when they wrote Friday's Natural Gas article, click here, they really outdid themselves. I judge the article as the best written, most insightful article I have seen in a long time. Before continuing, please stop now and read the article.

    In 2009, 2012 and 2015, natural gas bottomed in April, and then rallied. In all three years the bottom was retested and was followed by another rally. We have completed 3 weeks of the second rally and are now approaching the critical 4th and 5th weeks of this second rally off the lows. To see where we are, take a look at the daily chart of July Natural Gas:

    On Friday, July Natural Gas broke below the low scored on the previous Friday, by just 4 ticks, and then reversed to close strongly, back above $2.800. This sets us up for a further rally this coming week, to continue the patterns of 2009 and 2012. However, the following week, week 5, there was a divergence, as pointed out by Main Street Trading. In 2012, we kept rallying but in 2009 we rolled over and eventually made a new low of the year.

    My Best Guess

    My best estimate right now, is that we roll over and make a new low for the year, similar to 2009. In 2012, natural gas traded above the March high in both weeks 3 and in weeks 4. In 2009, like 2015, we failed to take out the March high in week 3, just completed, missing the high by 19 1/2 cents. If we fail to trade above $3.15 this coming week, which is quite doubtful since it would require a rally of over 34 cents, then we are more aligned to the 2009 pattern and could move lower and make a new yearly low in August and September. I suspect that natural gas may struggle to trade above the high made this past week at $2.955 and likely will stop short of $3.00 as well as the critical $3.15 point.

    Summary:

    In my last natural gas article, click here, I cautioned about a bearish hanging man pattern which ultimately was confirmed. I warned traders to take profits and most did. However, on the late week dip, traders have since aggressively accumulated shares in UGAZ again. With Friday's reversal, that strategy looks quite promising for next week. However, be prepared to completely liquidate all UGAZ shares on further strength, especially if we cannot take out the March high of $3.15. If we fail on the retest of the highs this coming week, it will be time to stop trading UGAZ and move into DGAZ. You won't want to favor UGAZ again unless we fall back towards the April lows. Again, this coming week could be your last best chance to sell your UGAZ shares at a nice profit. You have been warned!

    Disclaimer:

    The thoughts and opinions in this article, along with all STOCKTALK posts made by Robert Edwards, are my own. I am merely giving my interpretation of market moves as I see them. I am sharing what I am doing in my own trading. Sometimes I am correct, while other times I am wrong. They are not trading recommendations, but just another opinion that one may consider as one does their own due diligence.

    Tags: UGAZ, DGAZ
    Jun 20 1:35 PM | Link | 4 Comments
  • July Wheat Is Poised For A Small Rally

    July Wheat Is Poised To Rally

    If you ever thought you wanted to get your feet wet trading commodity futures, there may not be any better time than right now, learning to trade futures using the mini wheat contract on the Chicago Board Of Trade (now owned by the Chicago Mercantile Exchange so go to cme.com for info). We are approaching the time when the winter wheat crop goes into harvest (July) and prices typically bottom at harvest time. Consider the following daily chart of July Wheat:

    (click to enlarge)

    I started following this chart closely in the middle of May. I saw significant resistance between $5.25 and $5.50 and decided to play the short side selling all rallies at $5.25 or higher. Although we traded $5.25 or higher four times, we never got a close above $5.25 and rolled over. That made for some very easy trading.

    When we dropped to a bottom on June 1st at $4.74, I meant to get long the market that day but failed to get my order placed as I was busy trading other things. There was no correction and within a couple days we were right back up to the $5.25 level where I again began going short by selling July Wheat futures contracts. This time we managed to get two closes above $5.25 and hit a high of $5.37 1/4 before rolling over. We rolled over to just above a trend line which one can draw from the $461 low, across the $474 low, and hitting around the $4.85 level now. At that point I switched from shorting to going long. I began buying July Wheat, near the close on Monday, June 15th. You will notice that we have now traded 3 days with a distinctive Gravestone Doji Japanese Candlestick pattern. Today's action has a slightly larger real body and is more like an inverted hammer.

    When you get this type of a pattern at the top of markets they are called shooting stars and mark a top. That makes a lot of sense because when you shoot high up during the day and lose all your momentum and come crashing back to the ground at the end of the day, it is a sign of exhaustion of the up move. It shows the market is tired and needs to take a rest by having a correction. It has a small body at the bottom and long tail, just like a shooting star. However, after a long selloff, you can get these gravestone doji patterns that shows that selling is exhausted. The market is trying to rally but is being knocked back by the end of the day as bulls get discouraged and cash in their profits. Still not enough power to bottom and move higher, but with every attempt the market is gaining internal strength. The ultimate conclusion should be at least a day or two of higher movement.

    Being a grain market and knowing how grains trade, I knew that when buying I would need to take profits on any strength because the strength would likely not last till the end of the day. However, by the close I wanted to be long again to take advantage of the rallies expected the next day. This has now been repeated for 3 days, and we have the last 4 closes all bunched together at almost the exact same level. When you get cluster closes at a top it is bearish, or like here, at the bottom, it is bullish. I anticipate a strong rally moving up above $5.00 either tomorrow, Friday, June 18th or on Monday, June 21st.

    If I am wrong about the rally and we get a down move instead, I will add more contracts on the next down close to average down, and from that low, we should still get a rally. What gives me more hope that we are likely done going down for now in July Wheat, is the fact that Monday's low at $4.86 has held for the past 3 additional days of trading. That is very constructive. The last time we got cluster closes was the period of May 6th to May 13th, when 5 of 6 closes clustered around the $4.80 level. On May 14th, the market exploded higher and hit $5.15 that day, a rally of just shy of 25 cents. Don't be surprised to see a similar large upward thrust move in the next couple trading days.

    Trade The Mini Contracts Over The Full Contracts To Learn

    Instead of playing full 5,000 bushel contracts where a penny move up or down is a gain or loss of $50, there are highly liquid mini contracts involving only 1000 bushels of wheat and a penny move only involves the gain or loss of $10. A typical daily range in wheat is 12 to 15 cents, so that means that with a mini contract, there is only a risk of $120 to $150 a day, top to bottom, vs. $600 to $750 on the full contract. Also, with the mini contracts you can buy every couple cents lower to get in to average down your breakeven price. On rallies you can do partial selling of your position when taking profits, selling more every couple cents that wheat rallies. You want to trade the Globex as the quotes are free, there is near round the clock trading, and you can place your own orders and the process is electronic. Don't trade the open outcry system that requires paying for quotes, and involving real people and paper being passed by a floor broker in Chicago. Live trading is old fashioned and inefficient, greatly increasing commission costs. At Interactive Brokers a mini contract to buy or sell is $1.89. The symbol for the full contract is "ZW" and the mini contract is "YW". If you trade July Wheat "N" stands for the month and "151" stands for the year 2015. So the quote in the full contract is written "ZWN15", and the mini is "YWN15". Hope this was helpful. Enjoy trading!

    For more up to the minute analysis, join us in our private Short Bull Trading Room on WeChat, just download the free app on your phone or tablet, and then add "bobed1". You can then send me a message so I can invite you into the room. Still plenty of room.

    Last Saturday I sent out my second issue of my free weekly newsletter. Send an email to shortbull2020@yahoo.com if interested in subscribing. It is free!

    Disclaimer:

    The thoughts and opinions in this article, along with all STOCKTALK posts made by Robert Edwards, are my own. I am merely giving my interpretation of market moves as I see them. I am sharing what I am doing in my own trading. Sometimes I am correct, while other times I am wrong. They are not trading recommendations, but just another opinion that one may consider as one does their own due diligence.

    Jun 18 3:24 PM | Link | 5 Comments
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