Grain Spreads: Dec 20 Hogs

Sean LuskGeneral Commentary

Commentary:

Hogs closed near last week’s close on Thursday but failed to extend gains this morning. December 20 Hogs, which we potentially see as undervalued (see chart below) is where we are suggesting a bullish option strategy. In my opinion the market is being pressured by increased tensions with China. Until more is known about Chinese buying intentions via the Phase 1 trade deal, the market may remain defensive. This week’s kill is running right in line with year-ago and up 30,000 head from last week. Big weekend kills have helped to push slaughter and pork production well ahead of year-ago, helping to work through backlogs. The abundance of pork has been met with strong demand, both from U.S. consumers eating more meals at home and from overseas buyers. That has helped cash hog bids and pork prices to stabilize in my opinion. The pork cutout value edged 34 cents higher yesterday, though movement was light to moderate, slowing from earlier this summer. Cash hog bids firms on Thursday with the national average price rising 62 cents. U.S. pork stocks in the nation’s freezers at the end of June were down a dramatic 155.1 million lbs. from year-ago. There is plenty of room to stock up ahead of a developing second wave of the virus that continues to keep supermarket pipelines for many items very tight.

China imported 2 million metric tons of pork in 2019, but it exceeded that total in the first six months of 2020 at nearly 2.2 million metric tons, putting it on pace to more than double last year’s total. Maintaining this pace in the last half of this year might be more challenging though, as China requires negative coronavirus tests on all meat coming into the country, creating congestion at its ports. It’s also suspending imports from some global processing plants with coronavirus outbreaks. I still view this as an opportunity as an inflation play coupled with Dec Hog futures at 50 cents which in my view is a discount.

Dec 20 Hogs

Trade Idea:

Futures-N/A

Options-3 way option spread here. Buy the call and sell a put spread to finance. Buy the Dec Hogs 70 call and sell the Dec 80/70 put spread. Bid -920 points on entry.

Risk/Reward.

Futures-N/A

Options-one is collecting 920 points or $3680 upon entry minus commissions and fees. The max loss is 1000 points here or 4K. However one is collecting 920 points or $3680 on the way in so the risk here is 80 points or $320.00 plus commissions and fees. The trade has unlimited upside in theory but realistically I would look for a protracted move towrds the gap which given the timing of the rally, should it occur, allow one to buy back the three way option spread cheaper from the level one sold it.

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