Crude Palm Oil’s underperformance
This chart caught our attention recently. The Crude Palm Oil – Soybean Oil Spread (in USD per Metric Ton) is trading close to an all-time high now.
This spells trading opportunity for us as Palm Oil and Soybean Oil are generally considered substitute products, which means, at a large enough price difference, buyers may hop over to buy the cheaper one. Eventually closing the price gap back to its historical mean.
Further comparison of Palm Oil against its other substitute, the European Low Sulphur Gasoil Financial Futures, also shows the spread between these products near the high.
A price comparison among the 3 products, Palm Oil, European low Sulphur Gasoil and Soybean Oil underscores this price disparity even clearer. The prices of the 3 products have generally trended together, up until July 2022 when Palm Oil started to underperform.
Stepping back into the macro side, some potential tailwinds for Crude Palm Oil include;
1) The reopening of China, which would increase the demand for palm oil from the world’s 2nd largest importer of the product.
2) Biofuel Mandates, which would put higher demand pressure on Palm Oil.
3) Slowing production growth in palm oil could lead to supply-demand imbalances, pushing palm oil higher as supply falters.
One way to trade this price divergence would be to short the Soybean Oil – Palm Oil spread. This trade can be set up by selling 1 Soybean Oil Futures and buying 1 USD Malaysian Crude Palm Oil Futures. However, do note that in such a set-up, the position is not fully ‘hedged’ as the contract units are different, 1 Soybean Oil Futures has a contract unit of 60,000 Pounds (~27.21 metric tons) while 1 Crude Palm Oil Futures is for 25 metric tons.
Another option would be to trade the exchange listed Crude Palm Oil – European Low Sulphur Gasoil Spread (POG) which handles the construction of the spread and is financially settled, removing delivery risk.
While it’s hard to ‘call’ the top, such price divergence provides interesting opportunities that we leverage if risk is managed properly. These trade set-ups allow us to express the view that Palm Oil’s underperformance will be closed, either by Palm oil catching up with its substitutes or if its substitutes fall in prices.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios.
Sources
cmegroup.com/trading/agricultural/files/spreading-cbot-soybean-oil-and-bmd-crude-palm-oil.pdf
cmegroup.com/education/articles-and-reports/palm-oil-spread-volatility-creates-opportunities.html
jakartaglobe.id/business/palm-oil-prices-production-to-drop-in-2023-gapki
oec.world/en/profile/hs/palm-oil
This spells trading opportunity for us as Palm Oil and Soybean Oil are generally considered substitute products, which means, at a large enough price difference, buyers may hop over to buy the cheaper one. Eventually closing the price gap back to its historical mean.
Further comparison of Palm Oil against its other substitute, the European Low Sulphur Gasoil Financial Futures, also shows the spread between these products near the high.
A price comparison among the 3 products, Palm Oil, European low Sulphur Gasoil and Soybean Oil underscores this price disparity even clearer. The prices of the 3 products have generally trended together, up until July 2022 when Palm Oil started to underperform.
Stepping back into the macro side, some potential tailwinds for Crude Palm Oil include;
1) The reopening of China, which would increase the demand for palm oil from the world’s 2nd largest importer of the product.
2) Biofuel Mandates, which would put higher demand pressure on Palm Oil.
3) Slowing production growth in palm oil could lead to supply-demand imbalances, pushing palm oil higher as supply falters.
One way to trade this price divergence would be to short the Soybean Oil – Palm Oil spread. This trade can be set up by selling 1 Soybean Oil Futures and buying 1 USD Malaysian Crude Palm Oil Futures. However, do note that in such a set-up, the position is not fully ‘hedged’ as the contract units are different, 1 Soybean Oil Futures has a contract unit of 60,000 Pounds (~27.21 metric tons) while 1 Crude Palm Oil Futures is for 25 metric tons.
Another option would be to trade the exchange listed Crude Palm Oil – European Low Sulphur Gasoil Spread (POG) which handles the construction of the spread and is financially settled, removing delivery risk.
While it’s hard to ‘call’ the top, such price divergence provides interesting opportunities that we leverage if risk is managed properly. These trade set-ups allow us to express the view that Palm Oil’s underperformance will be closed, either by Palm oil catching up with its substitutes or if its substitutes fall in prices.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios.
Sources
cmegroup.com/trading/agricultural/files/spreading-cbot-soybean-oil-and-bmd-crude-palm-oil.pdf
cmegroup.com/education/articles-and-reports/palm-oil-spread-volatility-creates-opportunities.html
jakartaglobe.id/business/palm-oil-prices-production-to-drop-in-2023-gapki
oec.world/en/profile/hs/palm-oil
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