Selling (Going Short) Live Cattle Futures to Profit from a Fall in Live Cattle Prices

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Contents

Selling (Going Short) Live Cattle Futures to Profit from a Fall in Live Cattle Prices

If you are bearish on live cattle, you can profit from a fall in live cattle price by taking up a short position in the live cattle futures market. You can do so by selling (shorting) one or more live cattle futures contracts at a futures exchange.

Example: Short Live Cattle Futures Trade

You decide to go short one near-month CME Live Cattle Futures contract at the price of USD 0.8445/lb. Since each Live Cattle futures contract represents 40000 pounds of live cattle, the value of the contract is USD 33,780. To enter the short futures position, you have to put up an initial margin of USD 1,620.

A week later, the price of live cattle falls and correspondingly, the price of CME Live Cattle futures drops to USD 0.7601 per pound. Each contract is now worth only USD 30,402. So by closing out your futures position now, you can exit your short position in Live Cattle Futures with a profit of USD 3,378.

Short Live Cattle Futures Strategy: Sell HIGH, Buy LOW
SELL 40000 pounds of live cattle at USD 0.8445/lb USD 33,780
BUY 40000 pounds of live cattle at USD 0.7601/lb USD 30,402
Profit USD 3,378
Investment (Initial Margin) USD 1,620
Return on Investment 208.5185%

Margin Requirements & Leverage

In the examples shown above, although live cattle prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 4.7957%) required to control a large amount of live cattle represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

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Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Selling (Going Short) Feeder Cattle Futures to Profit from a Fall in Feeder Cattle Prices

If you are bearish on feeder cattle, you can profit from a fall in feeder cattle price by taking up a short position in the feeder cattle futures market. You can do so by selling (shorting) one or more feeder cattle futures contracts at a futures exchange.

Example: Short Feeder Cattle Futures Trade

You decide to go short one near-month CME Feeder Cattle Futures contract at the price of USD 0.9520/lb. Since each Feeder Cattle futures contract represents 50000 pounds of feeder cattle, the value of the contract is USD 47,600. To enter the short futures position, you have to put up an initial margin of USD 2,025.

A week later, the price of feeder cattle falls and correspondingly, the price of CME Feeder Cattle futures drops to USD 0.8568 per pound. Each contract is now worth only USD 42,840. So by closing out your futures position now, you can exit your short position in Feeder Cattle Futures with a profit of USD 4,760.

Short Feeder Cattle Futures Strategy: Sell HIGH, Buy LOW
SELL 50000 pounds of feeder cattle at USD 0.9520/lb USD 47,600
BUY 50000 pounds of feeder cattle at USD 0.8568/lb USD 42,840
Profit USD 4,760
Investment (Initial Margin) USD 2,025
Return on Investment 235.0617%

Margin Requirements & Leverage

In the examples shown above, although feeder cattle prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 4.2542%) required to control a large amount of feeder cattle represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

Learn More About Feeder Cattle Futures & Options Trading

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Projecting feeder cattle prices in 2020

Let’s take a simplified approach to looking at price projections. First, the long run.

Spring 2020 projections from the Financial and Policy Research Institute (FAPRI) at the University of Missouri are now suggesting that annual slaughter cattle prices might not bottom out until the year 2020, making the current cycle a 13-year event. FAPRI also suggests annual slaughter cattle prices could average $115 per cwt in 2020, $113 in 2020 and $110 in 2020 (Figure 1).

FAPRI further suggests that the next cycle may peak sometime in the 2028 era. Drought in cow country is the biggest factor that can directly change these projections.

This is fine for a long-run perspective. Let’s now focus on a short-run perspective for feeder cattle.

Figure 2 presents my latest short-run feeder cattle price projections generated in my latest monthly price analysis. Most of the table values are devoted to feeder steer prices. Slaughter price projections are near the bottom, along with suggested slaughter cattle basis (cash minus futures). Grass steer price projections are at the bottom, and are used for budgeting going on grass and coming off grass each growing season.

The red numbers in the feeder price section are my planning prices used for going on grass in the spring and coming off grass in the fall. The bottom-line red numbers are the sell-buy margin (price off grass minus price on grass) for grass cattle, used to estimate the marketing loss on the original purchase weight.

Quick price projection update

Since you’re reading this article later than the projections were generated, you might want to do a quick update of the projected selling price for grass cattle to see how things have changed from these late-April 2020 projections.

Let’s focus on an October price for selling your grass steers off grass — the $153-per-cwt red number in the Fall ’18 column in Figure 2. When the $180 Spring ’18 price going on grass is compared with the projected $153 off-grass price in Fall ’18, the buy-sell margin is a minus $27.

This means with a 600-pound feeder going on grass at $180 per cwt and an 800-pound feeder off grass at $153 per cwt, I am projected to have a marketing loss on the original purchased 600-pound feeder of (−$27 x 6.00 cwt) equal to $162 per head. I have to make this up on the 200 pounds of gain. This figures out to a marketing loss of $81 per cwt of gain.

My projected total grazing cost of gain is $60 per cwt, including an annual grass rental charge of $90 per head, making my marketing loss plus cost of gain equal to $141 per cwt of gain. The buy-sell margin loss is even greater than the actual cost of gain. A market price of $153 and a total production cost of $141 leaves profit of only $12 per cwt of gain, or a projected $24 profit per head from running grass steers based on late-April price projections.

Let’s say on July 15 you look at Feeder Cattle futures prices and see that October Feeder Cattle futures price that day closed at $165 per cwt. Feeder Cattle futures prices are for 800-pound feeders, but you hope to market an 850-pound feeder off grass. So, how do we adjust the Feeder Cattle futures price for an 850-pound feeder in the cash market?

We can use a “basis adjuster” to generate a price adjustment for the cash market and the extra 50 pounds of weight. How I make the basic adjustment in my computer models is shown in Figure 3.

Basis is defined as cash minus futures. Each mid-month, I calculate the eastern Wyoming-western Nebraska basis (sale barn cash price minus the current Feeder Cattle futures price) for sale barn feeders from 425 pounds to 925 pounds, and my calculated last three-year average basis by feeder weight, as shown in Figure 3.

Now let’s say that on July 15, I see that Feeder Cattle futures for October closed at $165 per cwt. Now I want to adjust this futures price to project the eastern Wyoming-western Nebraska sale barn cash price for when I sell in October.

Let’s assume it has been a good grazing season, and I expect to sell 850-pound feeders off grass rather than 800-pound feeders. My calculations suggest a three-year basis average for an 850-pound feeder of a minus $2.65. So my new July 15 price forecast for an 850-pound feeder steer in October is ($165-$2.65 = $162.35), rounded to $162 per cwt. This is my updated projected sale barn price for grass cattle weighing 850 pounds.

This new price projection takes all of five minutes to get a quick updated price forecast for selling your steers off grass. Write down your projections in your pocketbook so that you can see the developing trend as you do this once a week or once a month during grazing season. This price trend is important to plant in your mind and helps you think through your current marketing program for your grass cattle.

Update fall price projections

Let’s use this same system to update my weaning price projections of $185 per cwt in Figure 2 for 550-pound steer calves off the cow in October. Let’s assume that on Sept. 1 you get the closing Feeder Cattle futures price for October for that day, and it is $140 per cwt. But, once again, you need to adjust this futures price for 800-pound steer feeders to a cash sale barn price for 550-pound steer calves.

Figure 3 suggests that the three-year basis for 550-pound feeders is $39.62. Add $39.62 to the Feeder Cattle futures price of $165 per cwt and you get a new sale barn cash price forecast of $179.62, rounded to $180 for an October steer calf price.

With this up-to-date price projection, you can start evaluating alternatives for marketing your fall-weaned calves. Should you sell at weaning, background or retain? You can use this quick pricing technique to get some planning prices for marketing alternatives for your 2020 calves.

A similar approach works even better to project slaughter cattle prices, by using Live Cattle futures and Live Cattle basis numbers, readily available on the internet from various university Extension services, such as Iowa State University and Kansas State University.

Price watching, if it is easy and applies directly to your cattle, can become addictive and is a very useful cattle marketing tool.

Words of caution: The variation of the basis adjustments is high, and as the variation of these basis numbers goes up, it reduces the quality of the projected planning prices. This implies that you should concentrate more on the price trend through the production year than on the absolute projected price levels.

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