In Mon’s Trading Strategy Blog we discussed last week’s bearish divergence in WEEKLY momentum below 25-Feb’s 14.03 larger-degree corrective low that, combined with historically frothy sentiment/contrary opinion levels, is consistent with a broader peak/reversal threat.  To be sure, relative to the magnitude of the secular bull market, the past couple weeks’ sell-off attempt thus far remains well within the bounds of a BULL market correction.  But now that at least Dec-Mar’s uptrend has been broken, a recovery above 23-Mar’s 15.20 high is required to CONFIRM this setback as such a correction and reinstate the secular bull trend.  UNTIL such strength is proven however, there’s no way to know the market isn’t in the embryonic stages of a peak/reversal process that could be major in scope and that warrants flipping the script to a non-bullish policy via long-covers and cautious bearish punts.

The daily log scale chart above shows the current weakness and vulnerability that began with 29-Mar’s bearish divergence in daily momentum below 16-Mar’s 14.50 corrective low that was reinforced with last Thur/Fri’s continued break.  Thur’s crop report-related break detailed in the hourly chart below leaves Thur’s 14.82 high in its wake as the latest smaller-degree corrective high this market is now minimally required to recoup to render the sell-off attempt from 23-Mar’s 15.20 key high a 3-wave and thus corrective affair that might then re-expose the secular bull trend.  Until such strength is shown, there’s no way to know the decline from 14.82 isn’t the dramatic 3rd-Wave of a much more protracted correction or major reversal lower.  Per such, this 14.82 level serves as our short-term risk parameter from which shorter-term traders with tighter risk profiles can objectively base and manage the risk of non-bullish decisions like long-covers and new bearish punts.  Against this backdrop, this week’s rebound is advised to first be approached as a corrective selling opportunity.

These issues considered, both short- and longer-term traders have been advised to neutralize all previously recommended bullish exposure and are further advised to consider initial bearish exposure and bear hedges with a recovery above either 14.82 and/or 15.20 required to threaten or negate this call commensurate with one’s personal risk profile.  Given the market’s confirmation of specific highs and risk parameters from which bearish decisions can be objectively based, as well as levels below the market it can and should achieve in the near-term per such a bearish count, we structured and discuss a favorable risk/reward bearish strategy below.


Taking advantage of the huge gamma differences between the May short-dated options that expire in 16 days and the Nov options that expire over six months from now, this strategy involves buying the May Short-Dated 14.20 Puts around 12-1/2-cents and selling the Nov 12.20 Puts around the same price for a net cost of about “even”.  This strategy provides:

  • a current net delta of -20%
  • nearly 7:1 gamma ratio
  • negligible risk to the upside if we’re wrong on a peak/reversal threat and the mega-bull resumes
  • profit potential of 2.00 on a sustained, trendy reversal lower below 14.20.

As always with such long-gamma diagonal spreads, time (i.e. theta risk) and LACK of directional price movement work against it.  If Fri’s crop report turns out to be a total dud and the Nov contract languishes laterally into mid-to-late-next-week, then this strategy should be covered in its entirety for what should be a small loss.  If the secular bull resumes in an explosive way, we cat on the premise that the long 14.20 put will erode to zero.  But the challenge then of having to leg out of the short 12.20 put that’s getting farther away is not a problem.  If the Nov contract tanks below Fri’s 13.94 low, then the 14.20 put will trade increasingly like an aggressive short futures position and easily outperform the losses incurred on the short Nov 12.20 put per the P&L graph below.  In NO event should traders allow the long put to expire worthless, leaving a naked short position in the Nov 12.20 put, if the technical prospect for a major peak/reversal remains intact.

Please contact your RJO representative for an updated bid/offer quote on the May Short-Dated 14.20 / Nov 12.20 Put Diagonal and good luck on Fri’s numbers.  

RJO Market Insights

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