Cattle & Livestock
This page was established for cattle and other livestock industry people. If you have never traded futures or options, you may want to check out our free educational material under the Beginner's Guide. Included in this are the risks of futures and options trading. Be sure to look for quality textbooks in our on-line bookstore, too. On-line and Premium Service account customers have free access to on-line commodity research. And, if you are getting ready to trade, why not first test your skills with one of our Real Live Paper Trading accounts? They are great learning tools and you receive a lot of educational support from our brokers.
To start using futures and options to protect your business profits, just send us a message at cattle@worldlinkfutures.com and we'll take it from there, or phone (800) 533-7080.
Protecting Business Profits with Livestock Futures & Options
What are Futures?
Futures contracts are traded on designated futures exchanges that are regulated by the Commodity Futures Trading Commission, a federal government agency. The specific terms and conditions of a futures contract, such as maturity, delivery grade, trading hours and contract size (to name a few) are all set by the futures exchange and are not negotiable between the buyer and seller. The buyer and seller only determine a price - the futures price. Prices fluctuate constantly, and are available over the Internet and in national business newspapers.
While futures are effective instruments for hedging price risk, they have some drawbacks. By locking in a specific buying or selling price, a futures hedge does not enable any participation in profits resulting from favorable price movements. In addition, the futures position itself may require additions of capital to be maintained, depending upon the direction of futures prices, and this may strain business working capital or bank credit lines. Alternatively, you may want to consider options.
What are Options?
For the privileges conveyed by an option, the buyer pays a price or premium which is the cost of the option (not including commission and fees). This money is paid upon option purchase and is non-refundable. You can think of buying an option as being similar to buying insurance. You pay the premium in return for protection against an adverse circumstance (in the case of a put option, cattle prices falling). Once the cost of the option premium is covered, no other capital is required regardless of how prices move; there are no margin calls. Thus, the holder knows upfront the total cost involved with an option hedge.
Despite the advantages provided by a put option purchase, many hedgers view the premium as a large expense. To reduce the net cost of the option hedge, the holder can establish an option fence or collar (sometimes called a window) in which options are sold as well as purchased. The revenue received from the options sold helps to offset the premium paid on the options purchased. Option fences are very versatile, and should be tailored to best match your price expectation.
Commodity futures and futures options are useful tools for hedging the price risk that can threaten business profitability in the beef production and livestock industry. For instance, cattle owners/investors who own or purchase feeder cattle in early Spring are at risk of a decline in the price of cattle as the Fall selling period draws near. As well, unexpected increases in the cost of various business expenses, such as the price of livestock food, or even interest rates, could also jeopardize profits. With futures and futures options, livestock people can manage the risk of these unexpected events, so that overall profits are protected.
A futures contract on say, live cattle, is a binding agreement between a buyer and seller to exchange cattle for cash some date in the future, referred to as the contract expiration date. The amount of cattle and the purchase price are known, but delivery is deferred - that is, the cattle, instead of being delivered and paid for now, are delivered and paid for on the expiration date. For instance, the cattle owner who sells an October 1997 live cattle futures must deliver 40,000 lbs of 55% choice/45% select USDA grade live steers in October to be received and paid for by the buyer of the live cattle futures. The selling price is equal to the futures price. So, if the owner sold the futures contract at 65.5 cents/pound, then he would receive $26,200 at the time of delivery of the $40,000 pounds of live cattle (calculated as $0.655/lb x 40,000 lbs = $26,200) less the cost of commission and fees. Even if cattle prices fall in October, say to 50 cents/lb, the owner would still receive 65.5 cents/lb for his cattle; he has locked in this selling price with the futures.
Options on futures are preferred by many businesses as a hedging vehicle because they provide protection against adverse price movements (just like a futures hedge), while also providing participation in profits if prices move favorably (unlike a futures hedge). A put option on a live cattle futures, for example, gives the holder the right to sell a live cattle futures, but the holder is under no obligation to do so. Clearly, they will decide to exercise the option (and sell a futures) if cattle prices fall. However, if cattle prices rise, they would be better off to let the option expire worthless and sell their cattle in the market at the higher price. The strike price of the put option specifies the selling price of the futures contract, and the minimum price that the holder will receive for their cattle less commission and fees. For example, an October 68 Put option on live cattle futures gives the holder the right, but not the obligation, to sell an October live cattle futures at 68.00 cents/lb anytime up to and including the first Friday in October, less commission and fees. If cattle prices are below 68 cents/lb by then, the holder will exercise the option and, by so doing, will have a short position in October live cattle futures established at 68.00 cents/lb. If cattle prices are well above 68 cents/lb by early October, though, the holder will let the option expire worthless and sell their cattle in the market at these high prices.