Sweet Divergence

Here is a nice little chart in Sugar. It shows the May-Oct spread on top and the May contract below. May and October are in different crop cycles, so this is an old-new crop spread.

The interesting thing here is how the spread was following the underlying, as you’d expect. Then it stopped and made a good case for a short position.

On the chart, note both the spread and the underlying make a low and a lower low in Feb (point A). Then as the underlying rallied in March, the spread did also, but reached a point where it no longer kept moving higher (point B).

You often see these divergences between the underlying and the spread. It’s not to say the spread knows better, but it can be a signal for a good risk/reward trade.

In this instance, you could have been short the spread from the start of March and not seen the position move against you.