October's Trade of the Month is a spread recommendation: Buy the February 2010 live cattle futures contract and sell the April 2010 live cattle futures contract. This is one of my favorite seasonal plays in years such as this.

I've discovered that in the late-September-to-early-October period whenever the February cattle futures of the coming year are trading at a discount (lower price) to the April cattle, there's a strong tendency for the February contract to gain on the April contract moving toward the February expiration.

This position is a spread, and when trading a spread it is not the price level--or even the direction of cattle prices (up or down)--that's important; what makes or loses us money is the change in the relative difference between the two months.

We can make money on this spread if the February gains on the April. This can occur in an up or a down market--in an up market if February goes up faster, and in a down market if it goes down slower.

The February cattle futures are trading at about a 2-cent-per-pound (or 200-point) discount to (under) the April cattle contract. The spread looks to have bottomed in 2009 with February at a 260-point discount to April on Sept. 22.

The current spread chart looks like this:

February 2010-April 2010 Cattle


Source: Commodity.com

Years ago I discovered this seasonal tendency: During years when the February cattle futures contract is trading at a discount to the April contract in the early fall, the February contract gains on the April as we move from the end of one year into the beginning of the next.

In many years the spread moves from a discount to a premium--the February contract trades higher than the April.

Here are some historical examples of the February-April spread moving higher from September-October of one year into February of the next. On the following charts a minus indicates the February contract is below the April; a positive number shows February is above the April.

February 1993-April 1993 Cattle


Source: Commodity.com

February 2001-April 2001 Cattle


Source: Commodity.com

February 2003-April 2003 Cattle


Source: Commodity.com

I have many more examples like this from the past 30-plus years. The odds are high this will work, greater than 75 percent according to my database in years like this--discount years--but there are no sure things.

Here's an example of a year in which this spread trade didn't work; in other words, February went to a greater discount to April:

February 1980-April 1980 Cattle


Source: Commodity.com

Then there are years like the following, when the spread works for awhile but you had to take the profit while it was available or else it would disappear:

February 1985-April 1985 Cattle


Source: Commodity.com

Some years the premium can really accelerate; I've seen the February cattle contract trade as much as 1,000 points over the April. This occurs in tough, cold winters, when the cattle have trouble gaining weight.

Cattle that would normally be ready for market in January or February are pushed back, creating a shortage of supply in this time frame. The market anticipates a glut by April, when these additional numbers become ready for market.

Certainly at this time we have no way of knowing how severe or mild this winter will be. However, the point is that there's potential for a big move here that we're able to pyramid along the way.

Bottom line, the timing and configuration appears to place the odds in our favor to enter the long February/short April cattle spread at this time. Every 100-point move in the spread (a 1-cent-per-pound change in the difference between February and April) equals a profit or loss of $400 per spread traded).

My recommendation for those willing to take the risk is as follows:

Buy February cattle and sell April cattle on a spread at 200 points or greater premium the April. Risk to 300 points premium the April (a risk in the neighborhood of $400 per spread traded). Leave the upside profit objective open at this time.

My plan would be to add to the position if it's working and also to raise the stop to lower the risk as the trade unfolds with the objective a February premium the April.

Based on history it's not unreasonable to expect the spread to trade back to a minimum 200 points premium the February, a profit potential of $1,600 or greater per spread traded.

For additional trade recommendations, consider George Kleinman's subscription-based service, Futures Market Forecaster. And be sure to check out George's new book, The New Commodity Trading Guide, available now at Amazon.com.

Risk Disclaimer. Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the Holy Grail. Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past results are not necessarily indicative of future results.

Hypothetical Performance. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.