Thursday, January 5, 2012

cattle market

Introduction to the Livestock Markets

Whether you are a rancher in the beef or pork industry or a seasoned speculator, the livestock futures contracts traded at the CME provide market participants with a liquid and transparent way to manage risk or speculate on price movement.
It is important to note that trading in this market involves substantial risks and is not suitable for everyone, and only risk capital should be used. Any investor could potentially lose more than originally invested.

What are the livestock futures contracts?
A livestock futures contract is a legally binding agreement for delivery of livestock in the future at an agreed upon price. The contracts are standardized by a futures exchange as to quantity, quality, time and place of delivery. Only the price is variable.
Market Personality
The meats have long been considered one of the more volatile markets because they have been known to be lock limit up and down in the same day. This usually happens on days where there is USDA report. This is not to say that the meats don't trend, but on any given day the markets can be extremely wild.
Hedgers and Speculators
The primary function of any futures market is to provide a centralized marketplace for those who have an interest in buying/selling physical commodities at some time in the future. The meat futures market helps hedgers reduce risk associated with adverse price movements in the cash market. Examples of hedgers would be food processors, ranchers and the food service industry.
Hedgers take a position in the market opposite of their physical position. Due to the price correlation between futures and the spot market, a gain in one market can offset the losses in the other.
For example, a rancher who is looking to sell his cattle sometime in the future is worried that prices will drop, and that he will get a lower price for cattle. So to 'hedge' himself, he will sell futures that will make money if the price of cattle drops. But if the market moves up, he will lose on the futures position but will make money on the sell of his cattle.
Contract Specifications
There are four different markets that trade livestock at the CME. They are: live cattle, feeder cattle, pork bellies and lean hogs.
Live Cattle
According to the CME, the live Cattle contract reflects current supply and demand for competing meats and feed grains, along with long term cyclical patterns for meat supply and consumer preferences.
Live Cattle is traded in dollar and cents per pound and one contract controls 40,000 lbs. If the current price is $0.90 per pound, the total value of the contract is $36,000. For example, if a trader was long one contract of live cattle at $0.9260/lb and sold at $0.9500/lb, they would make a profit of $960 ($0.95 - $0.926 = 0.024, 0.024 x 40000 = $960). On the other hand, if the trader had sold at $0.90, they would have lost $1040 ($0.926 - $0.90 = 0.026, 0.026 x 40000 = $1040).
The minimum price movement or tick is $0.00025 or $10 per contract. The exchange also has a daily limit that is the allowable daily move in a market. For live cattle, it is $0.03 or $1200 per contract.
The most active months traded (according to volume and open interest) are February, April, June, August, October and December.
The exchange will set position limits to maintain an orderly market, to make sure no one market participant has too many positions on at any one time. There will different limits for speculators and hedgers.
Live Cattle delivered in numerous places around the US in Syracuse, KS, Tulia, TX, Columbus, NE, Dodge City, KS and Amarillo, TX.
Pork Bellies
Frozen Pork Belly futures contracts are for what is essentially bacon in storage.
Frozen Pork Belly contracts are traded in cents per pound and one contract is for 40,000 lbs of cut and trimmed pork belly. Much like live cattle, each penny move equals a change in $400 for each contract. .
The tick size is $0.0025 or $10 per contract. The CME's daily limit for pork bellies is expandable, but starts off at 3 cents.
The most active months for delivery (according to volume and open interests) are February, March, May, July, and August.
Pork belly contracts, like live cattle, also have position limits set by the exchanges.
Delivery for pork bellies are at CME approved warehouses 'east of the western boundaries of North Dakota, South Dakota, Nebraska, Kansas, Oklahoma and Texas (CME Rulebook).'
Feeder Cattle
Feeder cattle represents living cattle to be placed in the yard for fattening. Feeder cattle is a derivative of live cattle.
The feeder cattle contracts are very similar to the live cattle contracts, the only difference being the size of the contract. Whereas the contract size for live cattle is 40,000 lbs, the size is 50,000 feeders. For example, if a trader was long from 105.50 and sold at 106.50, they would have made $500 (106.50 - 105.50 = 1 cent, $0.01 x 50,000 = $500).
The minimum tick is still $0.0025, but in feeder cattle that equals $12.50 per tick. The daily limit is $0.03, or $1500 per contract.
Feeder Cattle is traded in January, March, April, May, August, September, October and November.
Position limits apply.
Feeder Cattle is cash settled so there is no delivery.
Lean Hogs
Lean hogs trade similar to live cattle and pork bellies, in that one contract equals 40,000 lbs. and it is traded in cents per pound. So every penny move in hogs equals a $400 change in each contract. For example, if the market moved from 58 to 60 cents, that is a move of $800 per contract.
$0.00025 is the same minimum price move like the others 'meats.' Lean Hogs are traded in February, April, May, June, July, August and October. Position limits also apply.
Lean Hogs are also cash settled meaning no delivery.
The meats offer investors a lot of opportunity as they tend to feed off of grain prices and (lately) mad cow disease. Also, I would be aware that these markets are still pit traded which has its own inherent pitfalls. Any investor looking to profit from the meats needs to be aware that there are risks investing in such a volatile market.
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