Looking at the April Lean Hogs futures daily chart above, I see some Bearish indications. We should wait until we get continuation to the down side tomorrow, but I will be too busy at the Open tomorrow to be as effective as I can be today when I have time to make a considered move. So, I decided to get in short early even though I recognize this could hurt if it goes the other way.
Here are the Bearish indications I see:
- 3 Drives to a top.
- Bearish Engulfing candlestick pattern.
- Close below the 8ema. 1st candle to do so since the drive began.
- Close near candle bottom on today's and yesterday's candles.
- High Overbought Stochastics.
- High Volume, indicating enthusiasm.
For the Target, you could make an argument the 38.2% Fibonacci retracement would be a good place. It coincides with a Support and Resistance level. We may in fact exit at this level but judging from the Stochastics and the enthusiasm, it looks more likely we'll make it down to the 50% Fib, which also coincides with a Support and Resistance level. I drew 2 thin, white, horizontal lines to mark this S/R level. The 50% Fib is at 98.225.
So, we'll target the 50% Fib but retain the option to get out at the 38.2% Fib if conditions suggest that is a better idea when price reaches it.
Speaking of options, we entered our short position by buying an April 104 Put for 4.4250 points. The Lean Hogs market has no mini contracts and its a relatively thinly traded market that's only opened 9:30am ET to 14:05 ET. With a point value of $400/pt, we need to control our risk somehow, and Options are the only way.
The April 104 Put option cost 4.425 * $400/pt = $1,770. The underlying HE price was 105.550 at the time we bought the option. It had a Delta of 43%.
The best Stop would be just over the recent swing high at 112.850, but that's a little too much money to lose if we hit it. For example, let's say we use a Stop of 113. The loss would be approximately:
113 - 105.55 = 7.45 Points * 43% Delta = 3.2035 * $400/pt = $1,281.40.
So, instead, we're using a Stop that's just over the high of today's candle at 110. It could certainly be hit by a reasonable retrace tomorrow. A 50% retracement of today's Close (105.4) to the swing high at 112.85, would be (112.85+105.4)/2=109.125. A 61.8% retracement would be 105.4+.618(112.85-105.4)=110.0041. We used 110.500 as a Stop, which is over the 50% and 61.8% retracements, but not by much.
Our dollar risk amount is approximately:
110.50 - 105.55 = 4.95 Points * 43% Delta = 2.1285 * $400/pt = $851.40.
I say approximately because the Delta will change as price moves. If price moves against us, then the Delta should decrease a little. Which would be more than welcome. You can use the option Gamma to estimate the Delta when the underlying hits 110.50, but its not worth it in this case.
Summary:
Bought HE Apr 104 Put for 4.4250 points, when HE was 105.550.
Stop when HE is 110.50.
Target when HE is 98.325, which shades our expected target of 98.225 by .100 points for slippage.
.100 points is .1/.025 = 4 ticks in the future and .1/.0125 = 8 ticks in the option.
Risk: $851.40 from calculation above
Reward: 105.55 - 98.325 = 7.225 Points * 43% Delta = 3.10675 * $400/pt = $1,242.70
R:R = 1242.70/851.40 = 1:1.5 not a great ratio but given the uber Bearish investor environment, thanks to Russia's invasion into the Ukraine, plus the Bearish indications discussed above, I think its adequate to take the trade.
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