As recently discussed, the combination of:
- a confirmed bearish divergence in WEEKLY momentum amidst
- historically frothy bullish sentiment/contrary opinion levels and
- an arguably complete 5-wave Elliott sequence up from Jul’21’s 4,63 low
warns of a peak/reversal threat that could be major in scope. As a result of these elements, the market has identified 16-May’s 7.66 high as THE KEY high and risk parameter that this market is now required to recover above to negate this count and reinstate the secular bull trend. Until and unless such strength is shown, a larger-degree correction or reversal is considered intact.
On a smaller scale, 27-May’s 7.33 corrective high serves as a smaller-degree corrective high and short-term risk parameter this market is required to sustain losses below to maintain the impulsive integrity of a more immediate bearish count. Its failure to do so won’t necessarily negate a broader bearish count, but it would certainly threaten it enough to provide an opportunity for shorter-term traders with tighter risk profiles to neutralize bearish exposure ahead of a steeper corrective retest of 16-May’s 7.66 high OR resumption of the secular bull trend to new highs above 7.66.
Per our three reversal requirements, the market has satisfied the first: a confirmed bearish divergence in momentum. As for the second and third requirements- proof of impulsive 5-wave behavior on the initial counter-trend decline and 3-wave corrective behavior on a subsequent recovery attempt- the jury remains out, with the extent of this week’s recovery thus far questioning a peak/reversal count. Nonetheless, while the market sustains levels below at least our short-term bear risk parameter at 7.33, at least the intermediate-term trend remains arguably down.
These issues considered, a cautious bearish policy and exposure remain advised with a recovery above 7.33 required for shorter-term traders to move to a neutral/sideline position and commensurately larger-degree strength above 7.66 required to negate this bearish count and reinstate the secular bull to levels indeterminately higher. Against this technical backdrop, we discuss below a bear hedge strategy for producers and a bull spec strategy for traders heading into Fri’s key crop report.
PRODUCER BEAR HEDGE: SHORT JUL SHORT-DATED 7.20 – 7.40 CALL SPREAD / LONG JUL SHORT-DATED 6.85 PUT COMBO
As a direct result of last week’s bearish divergence in weekly momentum and subsequent losses, the market has identified key resistant highs at 7.33 and especially 7.66 from which a more aggressive bear hedge strategy can be structured. Against this backdrop, we recommend selling the Jul Short-Dated 7.20 – 7.40 Call Spread for around 6-1/2-cents and buying the Jul Short-Dated 6.85 Puts around 7-cents for an initial net cost of about 1/2-cent. This combo strategy provides:
- a current net delta of -40%
- favorable margins
- fixed risk/cost of 1/2-cent if the underlying Dec contract settles anywhere between 6.85 and 7.20 at expiration 17 days from now on 24-Jun
maximum risk/cost of 20-1/2-cents on ANY rally in the underlying Dec
contract above 7.40
- allowing the producers cash position to continue to profit
- virtually unlimited dollar-for-dollar downside hedge protection below its 6.84 breakeven at expiration.
BULL SPEC: LONG JUL SHORT-DATED 7.40 / DEC 9.70 CALL DIAGONAL
As this week’s recovery has opened the prospective door to a resumed bullish count that contend the recent drop from 7.66 to 6.82 is a 3-wave correction ahead of a resumption of the secular bull, speculators may fancy the low risk and very favorable return of a long position in the Jul Short-Dated 7.40 / Dec 9.70 Call Diagonal. This strategy involves buying the Jul SD 7.40 Calls around 9-1/4-cents and selling the Dec 9.70 Calls around 10-1/2-cents for a net cost of about a 1-1/4-cent CREDIT. This strategy provides:
- a current net delta of +21%
- a whopping 8:1 gamma ratio
- favorable margins
- upside profit potential of over $2.00 on a sustained rally above 7.40
- negligible risk if the underlying Dec contract tanks as a result of Fri’s crop report.
As always with long-gamma diagonal strategy, the biggest risk is time decay, or theta. Theta is the counter to the immense gamma advantage the Jul SD calls enjoy over the Dec calls. As the P&L graph shows, this strategy suffers gradually from market INactivity. If Fri’s report is a total dud and the Dec contract flatlines, the long Jul SD 7.40 Call will lose time premium and a faster clip than the Dec 9.70 Call will. Left unattended under such merely lateral price action, the long SD call will erode to zero, leaving a naked short position in the Dec 9.70 call. Such a predicament exposes infinite risk, so we NEVER allow this strategy to reach that point. If the market doesn’t MOVE BIG, either way, by mid-next-week as a result of Fri’s report, this entire spread should be covered for what should be a small loss. If the underlying Dec contract resumes the secular bull trend however, the high-gamma Jul SD 7.40 Call will quickly behave like an aggressive long futures position, severely out-perform the losses on the much-lower-gamma short Dec 9.70 Calls.
Please contact your RJO representative for updated bid/offer quotes on these strategies and good luck on Fri’s numbers.