Trading guides, webinars and stories
Trading guides, webinars and stories
The term “Cattle Futures Market” can be somewhat difficult to grasp. Not everyone is familiar with what it represents, how it works, and how it can be used to grow an investor’s portfolio. The thing is, understanding how the cattle futures market works isn’t actually difficult. It’s basically a commodity futures contract with the underlying asset being livestock. Sure it does require a bit of legwork from traders and investors to get started. However, once that is out of the way, the rewards of trading cattle futures can be surprisingly immense. Plus, it affords a feasible way to diversify a portion of your portfolio. Specifically, by shifting your focus on commodities, while taking it away from traditional asset classes, such as stocks and bonds.
As you already know, today’s cattlemen can physically sell cattle any time in a variety of ways. These include auctions, private treaty, video sales, and other venues. Normally, on the day of the sale or a few weeks after the sale, the cattle are moved from one location to another. However, there are instances where the physical ownership of the cattle sold does not change for a few months. Instead, the buyer and the cattle producer agree to conduct the trade at an agreed upon price and time in the future. This contractual agreement represents the makings of a futures contract.
In simplest terms, cattle futures contracts are financial instruments that give the buyer the obligation to purchase a set amount of cattle on a certain date and for a certain price. This means that the futures contract buyer and cattle producer can lock down a price in advance so they are not at the mercy of price fluctuations at the time of sale.
Cattle ownership is a pretty significant investment. Therefore, producers need to be able to calculate their break-even points and lock in prices on their commodities for better price management. Instead of waiting and getting whatever the price happens to be in the future. For many cattle producers, a futures contract means they can mitigate risk to ensure they are still operating next year.
Who trades it?
The prices of these futures contracts are negotiated at futures exchanges, such as the Chicago Mercantile Exchange (CME) and the Brazilian Mercantile and Futures Exchange (BMF). The major players in the cattle futures market are mostly hedgers who are likely involved in a livestock-related business. These might include ranchers, leather manufacturers, and businesses in similar industries. However, with a brokerage account, anyone can get involved with futures contracts and gain access to the livestock market. For instance, in 1978, America’s former first lady, Hilary Clinton, is said to have converted a $1,000 investment into a windfall of nearly $100,000 through cattle futures trading.
Cattle futures trading started as far back as 1964 on the CME. These contracts have become quite popular since then. One vital reason for the popularity is that cattle have many uses aside from turning into the meat we eat. We also produce milk from them and their hides are good for leather. Basically, the value in cattle is clear, demonstrable, and easy to comprehend.
They are both traded on the CME. The underlying difference between them comes down to the age and weight of the cows. The “Live” category comprises of cows within the calf stage until they reach a weight of 600 to 800 pounds. This weight gain period can take anywhere from 6 to 10 months after the cow is weaned from its mother.
After that, the cows are transferred to feeder lots, some of which are large enough to accommodate up to 50,000 cows. These cows fall into the “Feeder” category and are kept there in order to gain enough weight to be ready for slaughter. The largest producers of cattle in the US are Texas, Arizona, Kansas, Colorado, Nebraska, California, and Iowa.
As mentioned previously, live cattle futures and options are traded on the Chicago Mercantile Exchange. The price is quoted in cents per pound. Various market players, including cattle producers, packers, consumers, and independent traders all trade using live cattle futures contracts. The reason this type of contract is so popular is because it gives all interested parties the opportunity to hedge their market positions and reduce the notorious volatility and uncertainty associated with live cattle prices. It also allows market participants to assess and bet on cattle demand and supply in the present and in the future.
Here’s an example and specs of a live cattle futures contract:
|Contract Ticker Symbol||LC|
|Contract Size||40,000 pounds (~18 metric tons)|
|Underlying Commodity||Live cattle|
|Price Fluctuation||$10.00 per contract ($0.00025/pound)|
|Trading Months||February, April, June, August, October, December|
|Trading Hours||Monday – Friday: 8:30 a.m. – 1:05 p.m. Chicago Time|
|Termination of Trading||12:00 Noon Chicago Time on the last business day of the contract month.|
Data Source:CME Group
Like with any investment, you need to be aware of what you’re getting into and understand the risks involved. In the case of live cattle, here are some potential risks worth considering:
Feeder cattle are crucial to the global ecosystem of beef production and is a vital commodity in the world. The industry is also responsible for millions of jobs, including suppliers, distributors and retailers. Consumption of beef worldwide is teetering at around 60 million metric tons annually, and the economic impact in the United States alone means the meat and poultry industry is worth $1 trillion. One of the most appealing features of feeder cattle futures is that they allow traders to play an active role in the all-encompassing market, which includes price demand for feed grain and the cattle themselves. In addition, traders are able to address price risk among those involved in the trade of feeder cattle for both the current and future outlook.
When it comes to trading, it is important to understand that the CME feeder cattle futures contract is settled on a cash basis. As such, the CME calculates an index for cash prices of feeder cattle based on a seven-day average. This index is calculated by averaging feeder cattle prices from the largest feeder cattle producing states in the US, as compiled by the U.S. Department of Agriculture (USDA).
The specs of the feeder cattle futures contract include:
|Contract Ticker Symbol||FC|
|Contract Size||50,000 pounds (23 metric tons)|
|Underlying Commodity||Feeder cattle|
|Price Fluctuation||$12.50 per contract ($0.00025/pound)|
|Trading Months||January, March, April, May, August, September, October, November|
|Trading Hours||Monday – Friday: 8:30 AM. – 1:05 PM Chicago Time|
|Termination of Trading||Last Thursday of the contract month with exceptions for November and other months, 12:00 PM|
Data Source:CME Group
Feeder cattle investing share similar risk factors with live cattle. It doesn’t attract much open interest or trading volume, yet the market tends to be volatile and uncertain. There’s also the fear of BSE diseases, which can impact feeder cattle prices on a global scale. In some cases, outbreaks have resulted in outright bans in certain countries, which led to the destruction of livestock in a bid to reduce the risk of spreading the disease. Other potential risks worth considering include:
Cattle futures may be risky contracts to trade, but it is undeniable that there is potential to make significant profits. This is especially true if you have a good grasp of your investment strategy. If you’re thinking of giving it a go, here are some strategies you may want to look into:
A.) Invest in a diversified basket of commodities that includes cattle futures contracts
Due to the price volatility of cattle futures, you’ll want to think carefully before taking large speculative positions in the commodity. One good way to mitigate this risk is to invest in a basket of commodities that includes cattle, poultry, other agricultural commodities, metals, and energy. This approach can help you accomplish two goals:
B.) Look for imbalances in the prices between live and feeder cattle
The prices of live cattle and feeder cattle are highly correlated, which often leads to traders trying to profit from the spread between the two. For instance, some traders capitalize on the price spread between live cattle and feeder cattle, as well as the price of the corn and hay needed to feed them. So what traders often do is buy live cattle futures and sell futures in feeder cattle and corn.
While this is a sound strategy, traders can also benefit from price discrepancies between the two types of cattle. Feeder cattle represent future supply, so any disruption will most likely influence the price and the demand of live cattle. In the event of live cattle oversupply, the price for new cattle coming onto the market will also be affected.
C.) Trade in meat production and processing stocks
If you’d rather skip the nitty-gritty of futures trading, then you could invest in the finished products of cattle; beef. Buy stocks of large beef exporters like Tyson Foods or Cranswick, and then treat it as you would your other investments. However, you must be willing to consider the myriad of other variables that applies to stocks like this. The price of cattle is just one of the many factors that drives their share prices.
If you’re looking for more in-depth and technical trading strategies for cattle futures, check out this CME guide. It outlines hedging strategies for both inventory and procurement protection.
Based on historical data, cattle prices tend to increase just before and during the summer months – but not necessarily because it is prime grilling season. After all, the feeder cattle used to supply that beef were already being priced back in February and March. Conversely, summer is when feed supplies are lower and more expensive.
So while some of the cattle can be replaced on the feedlots, it is not always enough to meet the increased demand. That’s because cattle feed supplies, such as corn and soybeans, tend to dwindle into the autumn months. By fall, however, the cattle feed is harvested, bringing in a new wave of cheaper feed supplies. This prompts cattle producers to begin rebuilding their inventory — beginning the new cycle.
This seasonal aspect of meat production, feed availability, and consumer’s desire for meat products directly affects the prices of live cattle futures prices. That said, it is also one of the features that make the cattle futures contract market attractive to commodity futures traders.
The United States Department of Agriculture (USDA) estimates that beef exports will increase by more than 2.7% in 2020. This is mainly because of the potential expansion of markets in Asia. For instance, on May 17, 2019, the overall CME market surged, following news that Japan was reopening full beef trade with the United States.
On the global scene, production of cattle is forecasted to grow 1% this year to 63.6 million metric tons. This growth is driven by Argentina, Brazil, and the US. These top producers and exporters are looking to increase their output to meet growing demand in Asian markets. They are also looking to capitalize on the weather-related herd reduction in Oceania as the anticipated competition in Asian markets is lowered.
With this anticipated rise in cattle supply, it is likely that the cost of feeding cattle will also rise this year. Especially as the feeds industry will work to keep up with the higher demand for live and feeder cattle.
While this article focused solely on cattle futures trading, you’d be pleased to know that you can also trade using other methods:
Beef need not only be on your dinner plate, but can also be part of your investing portfolio. Due to the modernization in emerging markets, demand for a protein rich diet has risen. Hence, the demand for beef is growing at unprecedented levels year over year. This longer-term demand could see cattle becoming a key profitable investment for traders and investors alike. That’s why even though the cattle futures market is smaller in comparison to other securities, it’s still worth taking a closer look at. Whether it’s live cattle or feeder cattle, futures contracts can definitely yield some pretty juicy gains. The key is to pay attention to fundamentals and the various factors that can influence the underlying price of cattle. For the technical side of trading and to learn how to navigate the cattle futures markets successfully, head to our Bootcamp webpage to enrol in our 6-month journey to becoming a better trader.