In recent updates we’ve discussed the unique and compelling combination of:
- a confirmed bearish divergence in WEEKLY momentum amidst
- historically frothy sentiment/contrary opinion levels and
- and arguably complete 5-wave Elliott sequence from Jul’21’s 4.63 low.
These technical facts and observation are shown in the weekly log chart below. Per the daily log chart above, last week’s break below 01-Jun’s pivotal 6.82 low confirms at least the intermediate-term trend as down and, most importantly, specifies 17-Jun’s 7.50 high as THE high this market must now sustain trendy, impulsive price action below to maintain a more immediate and major peak/reversal count. It’s failure to do so will render the sell-off attempt from 16-May’s 7.66 high a 3-wave and thus corrective affair and re-expose the secular bull market. Per such, this 7.50 level serves as our key long-term bear risk parameter pertinent to longer-term commercial players like producers.
The reason we make a point of this long-term bear risk parameter at 7.50 is because despite the peak/reversal elements listed above, the magnitude of the secular bull trend is so great that the past six week’s sell-off attempt still falls we within the bounds of a mere (4th-Wave) CORRECTION WITHIN that bull. We always bias WITH a wave count that is consistent with the developing trend, hence our preference for concluding the decline from 17-Jun’s 7.50 high is the dramatic 3rd-Wave of an eventual 5-wave sequence down. Such a count would be expected to be characterized by sustained, trendy, impulsive, accelerating losses straight away. This market shouldn’t come anywhere near 7.50 per this count, let alone take it out. A recovery above 7.50 would negate this count, confirm the May-Jun drop as a 3-wave and thus (4th-Wave) correction and re-expose the secular bull to new and indeterminable highs above 7.66, perhaps in a similar performance to that that followed the key crop reports in late-Jun 2012 that, along with early-Jul weather elements, exposed a 2-month, $3.00 shocker/resumption of the secular bull trend in the Dec12 contract shown in the monthly log active-continuation chart below.
Heading into this key environment in the weeks ahead relative to the highs, resistance and risk parameters identified above, as well as into Thur’s key crop reports specifically, we discuss a producer bear hedge strategy below that we believe provides preferred and favorable risk/reward metrics.
PRODUCER BEAR HEDGE: AUG SHORT-DATED 6.70 – 6.40 PUT BACK SPREAD
Given the market-defined highs, resistance and 7.50 risk parameter discussed above as well as the expectation that Thur’s key crop reports will instigate a MOVE AWAY FROM current 6.60-area prices, we recommend the Aug Short-Dated 6.70 – 6.40 Put Back Spread. This strategy involved selling 1-unit of the Aug Short-Dated 6.70 Puts around 35-1/4-cents and buying 2-units of the Aug Short-Dated 6.40 Puts around 20-cents for a net initial cost of about 4-3/4-cents. This strategy provides:
- a current net delta of -21%
- favorable margins
- fixed, maximum cost of 4-3/4-cents on ANY rally above 6.70 (which would allow the producer’s cash position to continue to profit)
- fixed, maximum risk of 34-3/4-cents if the underlying Dec contract settles at 6.40 at expiration 24 days from now on 22-Jul
- virtually unlimited, dollar-for-dollar downside hedge protection below its 6.05 breakeven point at expiration.
We opted for this put back spread strategy instead of the short call spread / long put “combo” strategy because of where the maximum risk/cost lies. In the “combo” strategy, maximum risk/cost would be incurred on a resumption of the secular bull trend that, as discussed above, certainly remains as a technical possibility. Alternatively, if the market has in fact topped and Thur’s reports are to provide the next grease to the slide, the market would be expected to fall apart pretty much straight away. Under this count, we would NOT expect the market to simply languish laterally over the next three weeks until expiration of the Aug SD options, or where this back spread strategy would incur its biggest risk/cost.
Please contact your RJO representative for an updated bid/offer quote on the Aug Short-Dated 6.70 / 6.40 Put Back Spread and good luck on Thur’s numbers.