IO Weekly Technicals Review [2024/43]: Term Structure Divergence
SGX TSI Iron Ore CFR China (62% Fe Fines) Index Futures (“SGX IO Futures”) closed nearly flat last week, down by just USD 0.10/ton on Friday after recovering from a mid-week decline.
SGX IO Futures opened at USD 101.65/ton on 21/Oct (Mon) and closed at USD 101.55/ton on 25/Oct (Fri).
Prices briefly touched a weekly high of USD 103.45/ton on 21/Oct (Mon) and a low of USD 98.10/ton on 24/Oct (Thu). It traded in a range of USD 5.35/ton during the week, which was smaller than the prior week.
Prices traded below the pivot point of USD 103.35/ton for the entire week but managed to hold support above the S1 pivot point at 97.65.
Volume peaked on 25/Oct (Fri) as Iron Ore prices rallied from near their low following the announcement of a parliamentary meeting to discuss the stimulus package between 4/Nov and 8/Nov.
SGX Iron Ore Futures Fundamentals in Summary
Iron Ore received support in the later part of the week from the announcement of a parliamentary meeting to discuss the stimulus package in China which will take place between 4/Nov and 8/Nov.
The People's Bank of China also said in a statement it had activated the open market outright reverse repo operations facility to "maintain a reasonable abundance of liquidity in the banking system and further enrich the central bank's policy toolbox“ ahead of a significant loan expiry at the end of the year.
IO China Portside inventories declined by 400k tons to 149.33 million tons last week. The decline was driven by slower arrivals as pickup volume declined week on week and steel mill’s restocking pace was below analyst expectations.
Based on seasonality, SGX IO Futures Nov contract trades 2.6% below its last 5-year average (USD 105.58/ton).
Seasonal Trend also suggests a price low is expected in the next few weeks.
Short-Term Moving Averages Signal Reversal of Bullish Trend
Prices began the week on a downward trend, marked by a bearish moving average (MA) crossover on 22/Oct (Tue). After the crossover, prices declined 3%, briefly dipping just above the S1 Pivot Point before recovering sharply on 25/Oct (Fri). On 28/Oct (Mon), prices are trading slightly below the 21-day moving average and the R1 Pivot Point for the week.
Long-Term Averages Signal Bearish Trend
Last week, the price traded below the 100-day moving average, closing just under this level. On 28/Oct (Mon), it rose sharply above the 100-day moving average but remains about 5% below the 200-day moving average.
MACD Points to Fading Decline, RSI Trending Higher
MACD indicates that the bearish trend is weakening, with the short-term MA beginning to curve upward toward the long-term MA. This suggests a potential consolidation around the long-term MA or a bullish crossover if momentum strengthens. Meanwhile, the RSI recently crossed above its 14-day average but remains near the midpoint at 53.84.
Fibonacci 61.8% Maintained Support Last Week
Volatility increased throughout the week but remains below early October levels. Last week, the price tested and held support at the 61.8% Fibonacci level from the prior uptrend. Fib levels from the recent downtrend suggest that the price may next retest the 38.2% level. The 61.8% level remains noteworthy, as it has previously acted as a key area of interest.
Low-Volume Node May Drive Sharp Upward Move
Despite ongoing selling pressure, buyers rebounded sharply in the latter part of the week. The price is currently at a low-volume node and could rise quickly toward the point of control, which aligns with the 50% Fibonacci level.
Calendar Spread Shows Deviation from Backwardation
The recent price movement has created a premium on the April 2025 contract compared to the second-month contract (Nov 2024). A return to the usual backwardation structure is expected. Additionally, speculation over the next two weeks, driven by the upcoming parliamentary meeting, will likely focus on the more liquid Nov 2024 contract, which should further support the spread.
Hypothetical Trade Setup
Iron Ore prices received some support from the announcement of further monetary easing and hopes of further stimulus at the parliamentary meeting next week. The rally has reversed the consistent decline in IO over the past 3 weeks but outlook remains bearish as the impact of stimulus on prices has weakened since early October. In the near-term, stimulus expectations may drive a rally clouding the outlook for a straightforward short position.
We propose a hypothetical trade set up of buying SGX IO November Futures Contract at USD 102.90/ton and selling the SGX IO April 2025 Futures contract at USD 103.60/ton to capitalize on the normalization of the backwardated term structure.
Presently the Nov/April ratio is at 0.99324. An increase to 1.025 presents a 3.25% increase in the spread which results in a gain of USD 321 to USD 330. A stop loss at the ratio of 0.975 protects in case of further decline with a potential loss of USD 189 to USD 194. This calculation excludes transaction costs comprising of clearing broker fees and exchange clearing fees. The SGX requires a minimum initial margin of USD 320/lot and a maintenance margin of USD 352/lot for this intra-commodity spread.
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Termstructure
Natural Gas: A look at term structureLast week , we examined Natural Gas from a seasonality perspective. This week, we aim to extend that discussion and explore other ways to implement a similar view.
To quickly recap: From a seasonality standpoint, we identified short-term opportunities for a downward move in Natural Gas. Factors such as higher-than-normal storage levels, unseasonably warm weather, and the typical price trends from December to January suggest a potential decline in prices. Additionally, prices have recently broken past initial short-term support, now trading below the $3 handle.
Another perspective worth considering is the term structure. Term structure refers to the difference between futures prices of various maturities of commodity futures. It is visualized by plotting the prices of different expiry contracts, forming what we refer to as the term structure curve.
The term structure reveals other insight that we can explore, starting with the basic slope, which can be categorized as flat, upward sloping, or downward sloping. Understanding these can reveal potential mispricing or provide a clearer picture of market expectations at different future points.
Contango
An upward-sloping term structure, known as "Contango", occurs where contracts closer to expiry are priced cheaper relative to those further from expiry. This can be attributed to factors like storage costs where contracts further from expiry might trade at higher prices due to the associated storage expenses. Sellers, therefore, demand higher prices to offset these costs.
Backwardation
A downward-sloping term structure, termed “Backwardation,” happens when prices in the near months are higher than those further from expiry. This might occur for various reasons such as a benefit to owning the physical material, also known as convenience yield or even just short-term demand pressures.
Term Structure
With a rough idea of contango and backwardation in mind, we can now look at Natural Gas term structure.
The chart above shows the term structure for natural gas 1 year ago, 6 months ago and yesterday.
Here we can see the 3 distinct shapes for the term structure, especially when we focus on the front part of the term structure. With the term structure a year ago deeply in backwardation, 6 months ago in contango and current term structure in a generally flat shape. We also observe that term structure shapes can change quite rapidly hence it can be valuable to look at the shape of the curve to place strategies on the term structure.
For instance, if we maintain a short-term bearish but long-term bullish view, one strategy could be to short the front part of the curve while going long on the back part. This can be achieved by creating a Jan – Jun 2024 calendar spread, going short on the Jan 2024 contract and long on the Jun 2024 contract.
What’s interesting when we look at the Calendar spread vs the outright price moves in the individual leg is that the direction of the outright contract moves generally dictates the direction of the calendar spread. Again, this could happen for a couple of reasons, one being that trading activity often concentrates on the front part of the term structure for liquidity reasons, hence, making the front part of the term structure generally more reactive than the back part of the term structure.
But why trade the calendar spread instead of the outright?
Reduced Margin
Benefits of trading the calendar spread instead of the individual month contract include lowered margin requirements due to margin offsets from CME, reducing the margin needed compared to outright positions.
Reduced sensitivity to risk/black swan events
Both long and short positions in a spread will react together to risk events, albeit to different magnitudes, mitigating overall exposure. For example, during the Natural Gas rally in 2021, while outright prices increased from $2.5 to $9.5, the Jan – Jun 2023 calendar spread only increased by $1 over the same period. Similarly, on the decline, outright prices fell close to $8, but the calendar spread fell by only $0.74. This relatively controlled price swing allows for more manageable risk compared to outright contracts.
Hence to express our short-term bearish but long-term bullish view, we can take a short position on the CME Henry Hub Natural Gas January 2024 Futures and a long position on the CME Henry Hub Natural Gas June 2024 Futures at the current level of 0.11.
The same position can also be expressed using the newly launched (on 6 November 2023) CME Micro Natural Gas. At 1/10 the size of the full-sized contract, the margin requirements to set up a position become more manageable.
Micro Natural Gas Futures Margin Requirements
Alongside the lowered margin requirements, it offers the opportunity to tactically average into a position to achieve a better average entry price for the same amount of capital.
Each 0.001 point move in the full-sized Henry Hub Natural Gas Futures is 10 USD while a move in the Micro Henry Hub Natural Gas Futures is 1 USD.
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 www.tradingview.com
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. A full version of the disclaimer is available in our profile description.
Reference:
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A Crude Awakening!The surprise production cut announcement from OPEC+ on Sunday caught us off guard!
With oil prices surging close to 7%, the question arises: will this trend persist?
To put the production cut into perspective, the unexpected 1.16 million barrels per day reduction is a continuation of the cuts announced last October. In total, these cuts will represent roughly 3.7% of global demand.
Since it has been some time since we covered oil, let's revisit some of the factors we see affecting oil now.
Strategic Petroleum Reserve
First, the US Strategic Petroleum Reserve (SPR) is currently at its lowest level since 1983. The remarkable depletion of the reserve to combat energy inflation finally ended in December.
How has crude oil performed since then? It has been trading relatively flat, with the recent news pushing crude back to its December peak levels. We view this as a potential positive for crude oil, as the current low SPR levels indicate that supplies cannot be easily smoothed out by artificial market forces to suppress oil prices. Furthermore, the SPR will eventually require a refill at some point, adding buying pressure.
Dollar weakness
As crude oil is quoted in USD, the dollar's performance greatly influences oil prices. The chart above depicts the dollar (inverted) against crude oil. Over the past 20 years, periods of dollar weakening have been associated with higher oil prices. With the recent dollar decline, we have yet to see a significant response from crude.
COT Positioning
Another interesting note about oil is the reduction of non-commercial long positions over the past year as oil rallied from the depths of negative prices in 2020. As long positions close, net positioning (blue) has returned to 2016 lows. The current positioning landscape presents opportunities for a renewed surge in Crude Oil if market participants re-establish their longs.
Term Structure
The term structure of Crude Oil remains significantly in backwardation, indicating possible demand pressures, as measured by the Dec 2023 – Dec 2024 spread as well as the Jun 2023 – Jun 2024 spreads. The news on OPEC production cut resulted in a spike in the steepness of the term structure, further emphasizing the presence of price pressures.
Political Gamesmanship
Last but not least, as global powerhouses China, Russia, and Saudi Arabia jockey for positions on the world stage, it's undeniable that oil plays a pivotal role in their strategic arsenal. By leveraging their influence over this vital commodity, these nations may attempt to exert pressure on the US, seeking to tip the geopolitical balance in their favor and assert their dominance in the energy market.
Looking at the charts, we see crude oil struggling to break lower after completing a descending triangle. The recent gap up has now positioned Crude Oil just above the 200-day moving average and descending triangle. Combined, the stage seems set for oil’s next leg higher as the low SPR levels, dollar weakness, term structure & net positioning act as potential tailwinds to propel Crude Oil higher. We set our stops at the previous support level of 73.15 and take-profit levels at 92. Each Crude Oil Future contract is equal to 1000 barrels of crude oil. Each 0.01 point increment in Crude Oil Futures is equal to 10 USD.
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 www.tradingview.com
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. A full version of the disclaimer is available in our profile description.
Reference:
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Term Structure Provides Fundamental CluesLast week, I wrote on processing spreads, a valuable tool that can provide clues about price direction. The price action in products that trade in the futures market like gasoline, heating oil, soybean meal, and soybean oil often tell us a lot about the path of least resistance for the crude oil and soybean futures contracts.
This week, I will turn my attention to term structure. Term structure is the price differential between one delivery period and another in the same commodity. Some traders call term structure time spreads, calendar spreads, front-to-back spreads, or switches. They are all the same, reflecting delivery or settlement premiums or discounts based only on time.
Backwardation- It’s what it sounds like
Contango- It’s not what it sounds like
A real-time supply and demand indicator
Commodities are unique- A mentor made a mint trading time spreads
Time spreads can enhance your commodity trading results- The cure for low and high commodity prices
The late Apple founder Steve Jobs once said, “My favorite things in life don’t cost any money. It’s really clear that the most precious resource we all have is time.” While Steve Jobs was referring to his mortality, time is a critical factor in commodities.
Close attention to term structure unlocks clues about fundamental supply and demand factors.
Backwardation- It’s what it sounds like
Backwardation is a condition where commodity prices for deferred delivery are lower than for nearby delivery. A backwardation suggests that supplies are tight, forcing nearby prices higher. The condition also indicates that producers will increase output in response to a market’s deficit, leading to lower future markets.
As of the end of last week, the NYMEX crude oil futures market was in backwardation.
The chart of NYMEX WTI crude oil for delivery in December 2022 minus the price for delivery in December 2021 was trading at over a $12 per barrel backwardation or discount. December 2021 futures settled at the $83.57 level on October 29, with the December 2022 futures at the $71.33 level. Robust demand, supply concerns, and other factors have driven the spread into the widest backwardation in years and NYMEX crude oil to the highest price since 2014. Higher crude oil prices tend to support a wider backwardation. Historically, the Middle East’s political volatility has caused supply concerns at higher prices as the region is home to over half the world’s petroleum reserves.
Crude oil is one example of a raw material market where the term structure reflects supply concerns. The trend towards a wider backwardation has been bullish for the energy commodity.
Contango- It’s not what it sounds like
While backwardation is a term that reflects the spread differentials, contango is another story. In the commodities lingo world, contango is backwardation’s opposite as it reflects a market where prices for deferred delivery are higher than for nearby delivery. Backwardation is a sign of supply concerns, whereas contango is present during periods of oversupply or equilibrium where supply and demand balance. The gold futures market is an example of a term structure in contango.
The daily chart highlights gold for delivery in December 2022 minus December 2021 is trading at a $10.30 contango or premium at the end of last week. The December 2021 futures were at the $1783.90 level, with the December 2022 contract at the $1794.20 level.
Central banks worldwide hold massive gold stocks as part of their foreign exchange reserves. Therefore, supply concerns tend to be low in the gold markets leading to a premium in its term structure. Moreover, gold has a long history as a means of exchange or money. Higher interest rates tend to push gold contangos higher.
Gold is one example of a commodity market in contango.
A real-time supply and demand indicator
A commodity’s term structure can be a helpful tool as it provides insight into supply and demand fundamentals. When a raw material price spikes higher because demand rises or supplies decline, the term structure tends to move into a widening backwardation. Producers respond by increasing output, creating the deferred discount.
When markets are in glut or oversupply conditions, producers often cut back on output, causing the chances for future deficits to develop. Thus, a steep contango can reflect the market’s perception that nearby oversupply will lead to eventual shortages.
Term structure is one of the puzzle pieces that comprise a market’s structure. The others are processing spreads, location and quality spreads, and substitution spreads.
Commodities are unique- A mentor made a mint trading time spreads
Commodities are essentials. Agricultural commodities feed and clothe the world and are increasingly providing alternative energy. Industrial commodities, including metals, energy, and minerals, are requirements for shelter, power, and infrastructure. Other raw materials have varying applications in daily life and even the financial system.
Shortages or gluts can have significant impacts on the global economy. The current inflationary pressures have roots in commodities, which had experienced price rises since the beginning of the worldwide pandemic when short-term lows gave way to bullish price action.
Supply chain bottlenecks and slowdowns or shutdowns at mines and processing facilities have put upward pressure on prices. Perhaps the most dramatic example came in the lumber futures market.
The quarterly lumber futures chart shows the price explosion to a record $1711.20 high in May 2021 on the back of slowdowns and shutdown at lumber mills and supply chain bottlenecks bringing wood to consumers during a period of rising demand. When lumber reached its May high, nearby January futures were far lower.
The chart shows January futures peaked at $1275 per 1,000 board feet, over $435 lower than the nearby contract at the May high.
When I worked at Phibro in the 1990s, my direct boss was Andy Hall, one of the most successful crude oil traders in history. While many market participants believe Mr. Hall churned out profits with long and short positions in the oil market, his greatest success came from what he called “structural risk positions.” He tended to buy the front months in the oil market and sell the deferred contracts when the market moved into contango. I remember the night when Saddam Hussein marched into Kuwait in 1990. The invasion caused the nearby price of crude oil to double in a matter of minutes.
Meanwhile, deferred oil prices declined, sending the spread to a massive backwardation. Mr. Hall pocketed hundreds of millions in profits on that night. His theory was that the risk of contango was limited over time, and the potential for spikes in backwardation increased the odds of success.
Time spreads can enhance your commodity trading results- The cure for low and high commodity prices
Commodity prices tend to rise to prices where producers increase output, consumers look for substitutes or limit buying, causing inventories to build. As supply rise to levels above demand, price find tops and reverse.
Conversely, prices tend to drop to levels where production becomes uneconomic. At low prices, consumers look to increase buying, and inventories decline, leading to price bottoms and upside reversals. The cure for high or low prices is those high or low prices in the world of commodities.
Meanwhile, highs or lows can be moving targets. As we learned in lumber and a host of other markets over the years, highs occur at levels that most analysts believe are illogical, irrational, and unreasonable. We learned the same holds on the downside as nearby NYMEX crude oil futures fell to a low of negative $40.32 per barrel in April 2020.
Time spreads can be real-time indicators of changes in a commodity’s supply and demand fundamentals. Understanding and monitoring term structure can only enhance the odds of success in the commodities asset class.
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Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.
Vix Term StructureThis shows all the different Volatility products. As you can see, when the 9d Vix goes above the longer term Vix's. Bad things happen. Why? Because if the 9 day vix is higher than the others, it means that people are more uncertain about what will happen in the next 9 days than the next few months. Just something to think about:)
OPENING: VIX APRIL 17TH 17/20 SHORT CALL VERTICALAnother "Term Structure" trade, this time in the April expiry. (I currently have one of these on in March -- a 16/19 short call vert).
Here, the /VX futures contract in April is currently trading at 17.10 or so, so I'm using that price as a guide for my short call strike.
Looking for a fill at .75-ish ... .
WHAT I'M LOOKING AT FOR EARLY 2017: VIX/VIX DERIVATIVE PLAYSWith Dough transitioning over to TastyWorks (it's basically Dough on steroids), I'm looking to wind up positions I've got on here over the next several weeks so that I can transition over to TastyWorks, which will not interface with TDA accounts. While I can naturally use ThinkOrSwim (ToS), it just doesn't have the features of Dough that I've come to know and love. Call it laziness, lack of "platform fluency," or a geezerly unwillingness to change, I'm not willing to "do without my Dough."
My original intention was to wind up everything in time for the TastyWorks roll out (Jan 3rd), but I figured I would just "carry on" until TW was firmly up and running, the mad rush at the TW doors had ebbed, and the inevitable glitches or kinks had been worked out. It is, after all "a new broker," and shit can happen ... . Generally, I prefer that shit happen to someone else. Okay, call me "lazy" and selfish.
In any event, being somewhat hobbled by the unavailability of Dough IVR/IV screeners here (I have other tools to screen for those, but they're extra work), my focus is going to pretty much be solely on short volatility product plays here over the short run, with the emphasis being on VIX "Term Structure" plays and "Contango Drift" plays in VXX and SVXY (UVXY is getting awfully close to reverse split territory, and I don't want to be in the middle of an options play when that happens; they're "messy").
Unfortunately, these are some of the most boring plays out there. For "Contango Drift" plays, you're basically sitting on your hands a lot, waiting for a pop in VIX, preferably to >20, and you can be waiting literally weeks for those to occur. With "Term Structure" trades, you put them on and wait sweatily for the VIX futures price to converge on spot, ideally below your short call strike before your options expire. If they don't, you look at rolling your spreads out for duration, which means (you guessed it), additional waiting for volatility to "come in."
I'll look at posting a "Contango Drift" example here, since I've already got some "Term Structure" examples out there to look at ... .