Cattle-hog spreads at unsustainable levels

Pavel Hála | Trading ideas | 30. 3. 2015

The nearest spread between live cattle and lean hogs (LEJ15-HEJ15) was formerly considered wide at levels above 30c. It’s trading above 100c right now and still rising. This situation is unsustainable from the long term perspective. It’s only a matter of time before these markets at least partially converge. The profit potential is great, but timing the entry is like catching a falling knife.

lej15-hej15

Rolling the trade into more distant expiration is complicated by extreme contango in hogs (blue vertical line in the LN histogram) and strong backwardation in cattle (blue vertical line in LC histogram) – both effectively act against any short cattle & long hogs trade.

LN_m_hist

LC_m_hist

Given the high risk, I would personally consider using options on futures to trade this idea. I would choose the August expiration and create two vertical spreads. One using call options on cattle and the other using put options on hogs. That would mitigate my risk, while allowing me to exploit this unique market divergence.

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