In all of our past month-and-a-half’s updates, we’ve discussed that while the technical elements typical of major peak/reversal environments like waning momentum, frothy sentiment and a potentially complete wave sequence are present, the market hasn’t provided the commensurately larger-degree proof of weakness to contend that the price action from early-May’s 6.38 intra-day high or 6.36 high daily close is that of a reversal, rather than a major bull market correction. Per such, long-term commercial players still have to acknowledge and be flexible to either directional outcome. A fact important to the effective navigation of this correction-vs-reversal dilemma however is that the market is currently wafting around the extreme lower recesses of the past couple months’ range, providing a unique and compelling risk/reward opportunity for those, like end-users, who need or want to take a bullish position.
Looking at the daily log close-only chart of the Dec contract above, it’s easy to conclude that this month’s decline from 10-Jun’s 6.15 high close is either the completing C-Wave of a major bull market correction from 07-May’s 6.36 high OR the dramatic 3rd-Wave of a major reversal lower. A clear break of 25-May’s 5.16 low and exact 61.8% retrace of Mar-May’s 4.53 – 6.36 rally will reinforce the peak/reversal count and expose potentially steep, sustained losses thereafter. IF, alternatively, the past couple months’ thus-far-lateral price action is (4th-Wave) consolidative, then somewhere along the line this market needs to, first, stem this month’s downtrend with a bullish divergence in short-term mo above 18-Jun’s 5.75 smaller-degree corrective high and short-term risk parameter AND THEN sustain trendy, impulsive price action higher thereafter. In effect, we believe the key shorter-term directional flexion points are at 5.75 and either 25-Mays 5.16 low close or 26-may’s 5.00 intra-day low.
Given the importance of the 5.16-to-5.00-area that HAS to hold as support for any broader bullish count to have a chance AND as a key risk parameter to any bullish decisions, again, current levels and conditions provide a favorable and objective risk/reward setup for those who need or want to take a bullish stance.
END-USER BULL HEDGE: AUG SHORT-DATED 5.40 – 5.10 PUT SPREAD / AUG SHORT-DATED 5.80 CALL COMBO
For end-users in particular, we believe this strategy has excellent risk/reward merits under the circumstances, especially given the opportunity to cover this hedge on a post-report break below 5.00. This strategy involved selling the Aug Short-Dated 5.40 – 5.10 put Spread for about 15-cents and buying the Aug Short-Dated 5.80 calls around 16-1/2-cents for a net cost of about 1-1/2-cents. This strategy provides:
- a current net delta of +47%
- favorable margins
- maximum risk/cost of 1-1/2-cents if the underlying Dec contract settles anywhere between 5.40 and 5.80 at expiration 25 days from now on 23-Jul
- fixed/maximum risk/cost of 31-1/2-cents on ANY plunge below 5.10, and
- unlimited, dollar-for-dollar upside hedge protection above its 5.81-1/2 breakeven point at expiration.
With what will be 23 days between Wed’s crop report and the Aug short-dated option expiration, the difference between “today’s” P&L of this strategy indicated by the red line in the graph versus the P&L at expiration (green line) is an important one. For while the maximum risk/cost on a resumed plunge in the underlying is 31-1/2-cents if no action is taken, covering this strategy on a technical break below 5.00 could reduce the risk/cost of this strategy by a third or more.
Please contact your RJO representative for an updated bid/offer quote on the Aug Short-Dated 5.40 – 5.10 Put Spread / Aug Short-Dated 5.80 Call Combo.