Livestock Marketing - Cash markets versus futures and options
Jay Parsons
Author
11/20/2020
Added
38
Plays
Description
Livestock Marketing
Searchable Transcript
Toggle between list and paragraph view.
- [00:00:03.030]Welcome to Livestock Marketing
- [00:00:05.660]Cash Markets versus Futures and Options.
- [00:00:08.100]My name is Jay Parsons.
- [00:00:09.287]I'm a professor in farm and ranch management specialists
- [00:00:12.602]in the Department of Agricultural Economics
- [00:00:15.830]at the University of Nebraska Lincoln.
- [00:00:19.545]In the last episode,
- [00:00:21.120]I discussed the importance of having a marketing plan,
- [00:00:24.640]and I mentioned that most producers
- [00:00:26.670]do not have a written marketing plan.
- [00:00:29.325]Matter of fact very few have a written marketing plan.
- [00:00:32.810]About half producers, half of the producers
- [00:00:35.091]claimed to have a marketing plan in their head
- [00:00:37.291]and about half don't really have a marketing plan at all.
- [00:00:42.982]We discussed the importance of having that
- [00:00:45.537]and being able to cover your cost of production
- [00:00:48.678]with that marketing plan.
- [00:00:51.660]In this episode, we'd like to dig into some of the tools,
- [00:00:54.242]specifically, some of the tools on the
- [00:00:56.990]Chicago Mercantile Exchange that you can use
- [00:00:59.414]to help implement that marketing plan
- [00:01:02.073]and meet those goals and objectives.
- [00:01:09.846]So it's important to understand what we mean
- [00:01:12.297]when we say cash markets.
- [00:01:14.254]Cash markets are those markets
- [00:01:17.023]where the agricultural commodity is physically traded.
- [00:01:22.240]So in cash markets,
- [00:01:25.660]we often refer to those as local markets,
- [00:01:27.772]or sometimes we call them spot markets.
- [00:01:30.234]So these are livestock auction barns
- [00:01:31.775]and more and more lately video auction sales
- [00:01:36.330]where prices are determined very directly
- [00:01:38.937]and completely on the spot.
- [00:01:41.923]It also involves direct and on-farm sales to feedlots.
- [00:01:45.865]Anytime that you're selling cattle
- [00:01:47.917]and somebody is paying you for those cattle
- [00:01:50.081]and taking delivery of them,
- [00:01:52.976]it is determined to be a cash market
- [00:01:55.455]if that price is determined on the spot at that time.
- [00:02:03.074]So which of the following markets
- [00:02:05.070]does your operation regularly use?
- [00:02:07.460]I mentioned auction auction barns,
- [00:02:09.890]video auctions and direct on farm,
- [00:02:12.530]or perhaps a combination of those.
- [00:02:14.431]This is a typical response I get
- [00:02:17.310]from the audience in Nebraska
- [00:02:18.560]when I go out and do extension.
- [00:02:20.774]Usually about two thirds of people in the audience
- [00:02:22.880]only use an auction barn to market their cattle.
- [00:02:26.772]The other one-third is usually split between those that use
- [00:02:30.229]exclusively a video auction to market to cattle
- [00:02:33.145]and those that use a combination
- [00:02:34.880]of that direct sales or on farms or
- [00:02:38.746]sorry combination of the video auction and the auction barn.
- [00:02:44.448]But that's a typical response I would get from an audience
- [00:02:47.490]in Nebraska when I'm doing extension programs
- [00:02:49.980]and I asked him this question.
- [00:02:51.270]So most people are getting that live bidding auction price
- [00:02:55.470]in the actual auction barn
- [00:02:57.480]but there's other tools available
- [00:02:58.997]to help you on this cash markets.
- [00:03:02.535]So a cash Forward contract would go different
- [00:03:05.537]than just a cash market price in the sense that
- [00:03:08.933]this would set that cash price for delivery of the animals,
- [00:03:13.850]but it'd be sometime in the future.
- [00:03:14.841]So this does involve physical delivery of the cattle.
- [00:03:20.970]It does involve a private relationship with a buyer
- [00:03:24.968]for that seller to connect with.
- [00:03:27.498]So it's usually written in some form,
- [00:03:29.767]video auction sales are often termed cash forward contracts
- [00:03:34.523]when the feature delivery is sometime out
- [00:03:36.333]in the distant future versus within the next day or so.
- [00:03:40.561]And same thing with direct and on-farm sales
- [00:03:43.650]where you're selling to a feed lot
- [00:03:44.970]but it's for say a month or two months down the road
- [00:03:47.480]you've already agreed upon the price for those cattle.
- [00:03:50.130]All of those that fall
- [00:03:50.963]onto the realm of being a cash forward contract.
- [00:03:56.758]Those are opposed to what we call the futures markets
- [00:04:00.500]and a lot of people get confused
- [00:04:01.980]when we start talking about futures and options
- [00:04:03.860]in the futures market in general
- [00:04:05.358]and think it involves a whole bunch of delivery of cattle.
- [00:04:09.740]Futures markets were developed
- [00:04:11.750]to standardized trading of commodities.
- [00:04:13.606]So all of these futures market contracts
- [00:04:17.059]have very standardized language in them
- [00:04:19.512]in order to set the prices.
- [00:04:21.341]So a futures contract for feeder cattle say in 2019
- [00:04:26.570]looks just like a futures contract for feeder cattle
- [00:04:29.092]back in 2015.
- [00:04:31.134]Rarely does the physical delivery of the cattle
- [00:04:34.430]actually take place between the buyers and sellers
- [00:04:36.780]on a particular contract is generally trading paper
- [00:04:39.474]where people sell a contract and they end up offsetting it
- [00:04:43.009]by buying a contract
- [00:04:45.420]which nets out to zero cattle delivered.
- [00:04:47.550]So we've talk about that as trading paper.
- [00:04:51.380]In the feeder cattle market
- [00:04:53.130]it's all settled electronically these days
- [00:04:55.410]there is no actual delivery of the feeder cattle
- [00:04:57.980]as a result of that contract.
- [00:05:00.140]Futures market prices do help determine
- [00:05:03.448]your local cash price.
- [00:05:05.096]The difference between that futures market price
- [00:05:09.103]and your local cash price is what we call the basis value.
- [00:05:12.200]Basis in general is just the difference between two numbers
- [00:05:15.440]and I use that term
- [00:05:17.160]when we start talking about cattle markets,
- [00:05:19.570]we're generally talking about the basis between
- [00:05:22.900]or the difference between what's happening
- [00:05:25.080]on the Chicago Mercantile Exchange
- [00:05:27.670]versus what's happening in the local pricing exchanges
- [00:05:31.750]which is usually in a local auction market.
- [00:05:36.014]So here's that relationship and math,
- [00:05:38.290]the cash price locally equals a futures price
- [00:05:40.828]plus the basis, or another way of saying that
- [00:05:44.068]is the definition of a basis
- [00:05:46.480]or simply the difference between the cash price
- [00:05:50.095]and the futures price.
- [00:05:51.589]Most often this basis is less than zero.
- [00:05:53.400]That is that the futures price
- [00:05:56.079]on the Chicago Mercantile Exchange
- [00:05:57.969]that the cash price is referenced to
- [00:05:59.929]than what you get in the local auction market
- [00:06:03.297]and that's because the transportation costs and so on
- [00:06:06.080]to get those to the bulk buyers of the commodity.
- [00:06:10.770]So you usually have a regional difference there
- [00:06:12.980]that plays into that.
- [00:06:14.690]In Nebraska, though,
- [00:06:15.780]especially when it comes to feeder cattle,
- [00:06:17.243]we typically have a positive basis
- [00:06:19.237]in that our local cash price in our auction markets
- [00:06:22.240]are typically trading above the futures price
- [00:06:25.590]that you will see on the Chicago Mercantile Exchange
- [00:06:28.952]for equivalent feeder cattle.
- [00:06:31.606]The reason for that is
- [00:06:33.359]even though we have a lot of cow calf operators
- [00:06:35.751]and a lot of calves being produced in the State in Nebraska,
- [00:06:38.417]we have relatively a large number of cattle on feed,
- [00:06:40.260]large feed lots of handle those
- [00:06:43.216]and large processing facilities
- [00:06:45.083]so we are a net importer of feeder cattle and fed cattle
- [00:06:48.200]to meet the capacity that we actually have in the state
- [00:06:52.210]for feeding cattle and for slaughtering cattle.
- [00:06:55.460]So our local calves actually bring a premium
- [00:06:58.870]above the futures price that you'll see
- [00:07:01.160]on the board of trade.
- [00:07:02.500]So our basis is actually positive here in Nebraska
- [00:07:05.690]most of the time for feeder cattle.
- [00:07:08.454]What are some factors influencing that basis though
- [00:07:11.500]supply and demand, the seasonality of the livestock markets?
- [00:07:15.620]The the basis will shrink when you have low supply
- [00:07:18.087]of the feeder cattle into the market and the and the buyers
- [00:07:22.178]of those cattle have demand for them.
- [00:07:25.480]So feed lot inventories get low
- [00:07:27.240]and they want to fill the feed lot
- [00:07:28.600]and there's not a lot of cattle out there.
- [00:07:31.850]You'll see that basis become more positive
- [00:07:34.095]for the actual seller of the feeder cattle.
- [00:07:37.560]On the other hand, when you have a lot of feeder cattle
- [00:07:40.510]being supplied, say at weaning time in the fall,
- [00:07:44.290]the feedlots they'll have demand up to a point
- [00:07:46.550]but as they begin to fill up, you'll see that basis wide now
- [00:07:50.582]for them in terms of being more favorable to the buyer
- [00:07:53.830]and they'll pay less for those cattle.
- [00:07:55.940]So basis is largely determined
- [00:07:57.683]by that regional supply and demand factors
- [00:08:00.863]and also it can be influenced by the actual
- [00:08:06.206]quality of livestock to some sense,
- [00:08:08.760]but we see that quality of livestock
- [00:08:11.270]in the auction sale barn really tick up
- [00:08:13.620]and make a difference there.
- [00:08:16.091]So good run on good quality cattle in a local auction
- [00:08:18.760]will make it appear on paper at least at that basis
- [00:08:21.221]is a much more favorable to the seller of cattle
- [00:08:25.000]in that region versus the futures market
- [00:08:26.830]which of course is just a standardized contract.
- [00:08:29.040]So the quality premiums and stuff that you might see
- [00:08:33.210]for particular cattle aren't gonna be reflected
- [00:08:35.590]in that futures contract like they would
- [00:08:38.836]in the local sale barn.
- [00:08:40.040]Also just the general competitive nature at the auction
- [00:08:42.650]the number of buyers and sellers present
- [00:08:45.000]can influence that local price
- [00:08:46.667]and of course, that non paper influence the actual basis.
- [00:08:51.925]so that cash price equals features price plus basis
- [00:08:55.510]is a relationship
- [00:08:56.760]so when you do a futures contract
- [00:08:58.770]in the Chicago Mercantile Exchange
- [00:09:01.075]you are locking in the futures price
- [00:09:02.130]which is just one of these three components.
- [00:09:05.110]And one are the two components that make up the cash price
- [00:09:08.180]you receive in the local marketplace
- [00:09:11.177]when you physically sell your cattle
- [00:09:13.269]it does not control the basis.
- [00:09:15.536]So CME exchange contracts do not affect the basis.
- [00:09:20.029]They only come in to help lock in
- [00:09:21.944]that futures contract price.
- [00:09:24.510]Options contracts lock in a floor or a ceiling
- [00:09:28.120]if you're a seller of an option, have the, a call option
- [00:09:32.740]which is an option to sell a futures contract.
- [00:09:35.089]So an options contract is simply the option
- [00:09:38.640]to sell a futures contract so when you do that,
- [00:09:41.770]it's called a put option and it sets in a floor
- [00:09:45.122]for that futures price.
- [00:09:47.230]LRP insurance contracts we'll talk about more detail
- [00:09:49.917]in the next episode is like an options contract
- [00:09:53.750]in that it locks in a floor on that futures price.
- [00:09:57.120]When you see a cash forward contract or a video sale,
- [00:10:00.470]it's used to lock in the full cash price.
- [00:10:02.653]So it's locking in both the futures price
- [00:10:05.620]and the expected basis.
- [00:10:07.970]Some people use a basis contract.
- [00:10:10.110]You'll hear that sometimes called
- [00:10:11.300]a formula contract in the trade.
- [00:10:14.847]That's used to lock in the basis by itself.
- [00:10:17.080]So when somebody offers you a formula contract
- [00:10:19.960]or talks about cattle being sold on formula,
- [00:10:22.510]they usually means that's a blocked in a particular basis
- [00:10:25.610]to a particular reference futures price.
- [00:10:27.930]So somebody might, for example, lock in a sale of cattle
- [00:10:30.880]at $5 above the October futures price.
- [00:10:34.856]And at that point when the actual cattle
- [00:10:38.119]are delivered in October,
- [00:10:39.434]they'll look at debt futures price, they'll see what it is
- [00:10:42.552]and the local buyer will pay you $5, 100 weight
- [00:10:45.826]above what that futures price is on that particular day
- [00:10:49.390]or whatever they use as a reference there.
- [00:10:53.490]So that's some of the lingo that you see on there.
- [00:10:54.759]Here's an example of the cattle futures contracts.
- [00:10:57.255]The feeder cattle contract
- [00:11:01.110]is in that seven to eight and a half 100 weight range
- [00:11:06.991]for medium frame number one steers.
- [00:11:10.373]And they're sold at 50,000 pound chunks.
- [00:11:13.882]So one contract is for 50,000 pounds of steers
- [00:11:18.600]that are expected to be in that 700 to 850 pound range.
- [00:11:22.870]These contracts are traded from January through November.
- [00:11:26.910]You can see here that if there's eight months of the year
- [00:11:29.912]that you can sell or buy a feeder cattle futures contracts.
- [00:11:34.751]The last business day of the of the month
- [00:11:37.667]is considered where your, these are expiring.
- [00:11:41.110]So if you sell a futures contract for October,
- [00:11:44.240]that contract is settled on the last business day of October
- [00:11:47.587]or whatever those contracts are trading at.
- [00:11:52.060]Live or fed cattle contracts are in 40,000 pound increments
- [00:11:56.240]and they're expected to be slaughter weight steers
- [00:11:59.026]and they are expected to grade 55% choice
- [00:12:02.163]or 45% select steer.
- [00:12:03.960]So again,
- [00:12:05.010]these are just standardized contract for pricing purposes.
- [00:12:07.436]Those are traded in six different months
- [00:12:10.335]that you see listed here from February to April,
- [00:12:14.330]in the spring, and then June and August and in the summer,
- [00:12:17.310]and then October December in the fall
- [00:12:19.580]and into the next part of winter.
- [00:12:22.800]So those are the months that those are traded in at again,
- [00:12:25.510]those are slaughter weighed animals
- [00:12:26.990]in 40,000 pounds per contract.
- [00:12:30.666]So what are some of the futures lingo we see out there?
- [00:12:34.730]People talk about offsetting a contract.
- [00:12:36.850]That is simply canceling a futures position.
- [00:12:40.350]You achieve this
- [00:12:41.183]by entering into an equal, but opposite contract.
- [00:12:44.566]So here's an example if you were to sell
- [00:12:46.510]for October feeder cattle contracts in April.
- [00:12:49.730]So April of the year, you look at the October contract
- [00:12:52.670]because you're wanting to lock in that futures price
- [00:12:55.259]for your October feeder cattle you sell four contracts okay.
- [00:12:59.022]That would be 200,000 pounds of feeder cattle steers that is
- [00:13:04.023]and that's 700 to 850 pound range
- [00:13:05.879]but you're doing that in April.
- [00:13:09.945]You would offset that or cancel that contract by buying
- [00:13:14.330]for October feeder cattle contracts.
- [00:13:16.708]Okay, so, and you're doing this before October 30th
- [00:13:22.140]because on October 31st, the last day of that month
- [00:13:25.224]this'll be automatically cash settled.
- [00:13:28.828]So we'll look at some examples of this
- [00:13:31.740]as we go through here.
- [00:13:32.830]So if I were to sell one contract on February seven
- [00:13:36.701]at 150.90 per 100 weight
- [00:13:38.694]for a feeder cattle futures contract,
- [00:13:41.983]that contract has a value of $75,450.
- [00:13:47.070]So that's what somebody is gonna pay me for that contract
- [00:13:50.320]when I sell it.
- [00:13:51.460]Okay, don't get too excited yet
- [00:13:53.100]because you gotta offset that
- [00:13:55.710]but that's the $150.90 100 weight
- [00:13:58.430]times the 50,000 pound contract.
- [00:14:02.230]When you do this, you gotta do it through a broker.
- [00:14:05.029]That broker is gonna charge you a commission
- [00:14:07.310]for that round turn trade.
- [00:14:09.562]That's usually relatively minor
- [00:14:11.998]'cause they're doing literally hundreds of these trades
- [00:14:14.490]in any given morning
- [00:14:17.398]or maybe even a thousand or more in a day.
- [00:14:20.206]So they're, they're getting their commission
- [00:14:23.042]and their income really off of volume.
- [00:14:25.892]So there'll be a minor charge for that commission.
- [00:14:27.860]There's also the big thing with a futures contract
- [00:14:30.250]as you need to have a deposit account on record
- [00:14:34.628]to cover any potential shortage.
- [00:14:36.724]This will vary depending upon your broker
- [00:14:40.274]but that's usually somewhere in that $4,000 range.
- [00:14:43.540]The reason for that is the CME
- [00:14:46.226]requires you to have enough money in your margin account
- [00:14:50.570]to cover the daily price limit change.
- [00:14:53.690]So if markets move against you
- [00:14:55.671]and you are losing money on your contract,
- [00:14:58.396]they want you to have enough money in your account
- [00:15:02.315]to cover the max you could lose in any one day
- [00:15:04.804]on that contract.
- [00:15:07.080]So at 3,375 which is what that was set at
- [00:15:11.810]at the time that I,
- [00:15:13.600]the most recent time that I checked on that
- [00:15:16.123]and I think that's still true today
- [00:15:17.490]that equates to about $6.75a a 100 weight
- [00:15:20.670]that you have to have maintain in a margin account.
- [00:15:23.284]So somebody would, your broker would ask you,
- [00:15:27.340]they'll set that deposit that they require,
- [00:15:29.610]it'll be somewhere higher than that 3375,
- [00:15:32.840]so say that's $4,050.
- [00:15:34.884]That cushion there
- [00:15:36.180]of of approximately $700 is how much cushion you have
- [00:15:40.010]before you drop below that maintenance margin
- [00:15:42.690]and if you dropped below that maintenance margin
- [00:15:44.780]at the end of the day, the broker calls you up
- [00:15:47.320]and tells you you need to replenish your account
- [00:15:49.500]back up to the $4,050 mark.
- [00:15:52.169]So you're gonna have to deposit more money
- [00:15:54.500]into your account.
- [00:15:55.333]That's what we call a margin call.
- [00:15:57.670]And that's what people don't like
- [00:16:00.094]about trading futures contracts
- [00:16:01.444]is they gotta keep money on deposit
- [00:16:03.715]to cover the maximum amount they could lose in one day.
- [00:16:05.940]And this is just for one contract.
- [00:16:07.620]So you can imagine people that have tens and twenties
- [00:16:11.083]number of contracts on trade at any one time,
- [00:16:15.398]they can they end up with several thousand dollars
- [00:16:18.350]in a margin account to cover that.
- [00:16:20.296]Alright, so let's continue with that example
- [00:16:23.161]and see how that would trade out.
- [00:16:26.850]So if you blocked in a sales at 150.90
- [00:16:29.766]and price ended up going down between and October
- [00:16:32.604]to 144.30, you would offset that contract
- [00:16:36.770]if you don't do it before then
- [00:16:38.800]the board of trade will do it for you automatically
- [00:16:41.560]and buy back a contract at that price.
- [00:16:44.138]So if the end of October rolls around
- [00:16:46.242]and you haven't offset this yet, it would offset it for you
- [00:16:49.895]at the October price of 144.30.
- [00:16:53.390]That means you actually made money on that, right?
- [00:16:55.510]You sold at 150 90, you bought back at 144 30
- [00:16:59.240]she made $6.60 per 100 weight on that round turn trade.
- [00:17:03.920]Your commission will be that you owe the broker
- [00:17:06.400]will be subtracted out of that and that's profit to you.
- [00:17:09.941]But that profit is likely to be offset
- [00:17:12.690]by lower prices that you receive in the cash market
- [00:17:15.377]as the cash market re reacts to this lower national price.
- [00:17:20.660]On the other hand, if the price goes up
- [00:17:23.380]to 155, a 100 weight,
- [00:17:25.716]you would again have to offset
- [00:17:27.750]at whatever that ending price is
- [00:17:29.126]if you don't do it along the way
- [00:17:32.420]so that 155 that you buy back at represents a loss
- [00:17:37.483]because you sold at 150.90, bought back at 125
- [00:17:41.537]you lost $4.10 a 100 weight on the round turn trade,
- [00:17:45.222]plus your commission.
- [00:17:47.275]So you lose money on futures contract, but most likely
- [00:17:52.141]you're have higher local cash prices
- [00:17:55.330]in reaction to this higher price
- [00:17:57.600]in the national marketplace.
- [00:17:59.660]So it nets out roughly the same
- [00:18:01.558]as long as your basis, doesn't change.
- [00:18:03.651]If your basis stays exactly the same,
- [00:18:07.120]you'll end up netting out what you expected to get here
- [00:18:10.890]with his contract plus the basis in your local marketplace
- [00:18:15.603]'cause they always end up offsetting each other
- [00:18:18.725]at some point here, whether it goes up or down
- [00:18:22.046]with losses or gains in the futures contract
- [00:18:25.765]or the CME exchange.
- [00:18:29.060]Put options or another,
- [00:18:30.190]because people don't like those margin calls
- [00:18:32.880]and because people don't like the idea of
- [00:18:35.070]if markets go up it still gets offset
- [00:18:37.758]and I don't get a benefit from that,
- [00:18:39.890]a lot of people like put options.
- [00:18:42.150]Put options are again traded through your broker
- [00:18:44.830]on the CMA exchange.
- [00:18:46.891]There's the right, but not the obligation
- [00:18:48.973]to sell a particular futures contract at a specified price
- [00:18:51.650]at any time during the life of the option.
- [00:18:54.500]So this establishes a price floor in the future
- [00:18:57.760]because it's not an obligation to sell that futures contract
- [00:19:01.458]which means you don't have to offset it if prices go higher.
- [00:19:05.298]So that's a nice little feature or the put options
- [00:19:10.130]people like that 'cause they can participate in that upside.
- [00:19:13.821]So options terminology, you have what we call a strike price
- [00:19:17.340]which is the specified price
- [00:19:18.748]at which the underlying futures contract may be sold.
- [00:19:22.360]And that's the case for a put, if it is a call option
- [00:19:26.154]it would be
- [00:19:27.430]the price at which you can buy that futures contract.
- [00:19:30.797]For the most part, unless you're a feeder,
- [00:19:33.920]if you're looking to buy and cattle to your feed yard,
- [00:19:37.044]you aren't necessarily using these options to buy cattle.
- [00:19:41.961]So as a cow calf producer,
- [00:19:43.749]you're most often using a put option here.
- [00:19:48.010]The premium itself is what it costs you to get the option.
- [00:19:50.098]You know that up front when you purchase it,
- [00:19:53.250]there's two components to it one of them it's
- [00:19:55.180]it is it's intrinsic value, which is the value
- [00:19:57.700]if it were to expire immediately,
- [00:20:00.660]and most often people buy put options
- [00:20:03.140]that are not of value intrinsically.
- [00:20:05.804]So they're looking to cover a portion
- [00:20:08.040]of that expected price not more than that expected price.
- [00:20:12.440]If you do cover more than that expected price,
- [00:20:15.414]we call that an in the money put option,
- [00:20:17.880]it has an intrinsic value then attached to it
- [00:20:20.620]and that's gonna be reflected
- [00:20:22.170]in the price you have to pay for it.
- [00:20:24.740]Time value is the other component
- [00:20:26.900]and that's the amount that the premium exceeds
- [00:20:30.150]the options intrinsic value.
- [00:20:32.060]So even though you might be buying something
- [00:20:34.410]that doesn't have current value to it,
- [00:20:36.640]what we might call an at the money put, right?
- [00:20:39.170]So the price strike price matches the current expectations
- [00:20:44.870]or the current price that contract's being traded at
- [00:20:47.580]so no intrinsic value,
- [00:20:48.510]you still gotta pay for that because there's a time
- [00:20:51.900]between now and then that you can exercise it.
- [00:20:54.633]A time value's gonna be reflected in that premium.
- [00:21:00.460]Okay, so here's an example
- [00:21:01.870]of that same October, 2020 feeder cattle contract
- [00:21:05.100]trading on February 7th at 150.90,
- [00:21:08.430]you might on that particular day that I looked at up,
- [00:21:11.610]the put option contracts that were available that day,
- [00:21:15.690]there was an at the money put at 150
- [00:21:17.710]or relatively at the money put you out 90 cents
- [00:21:21.063]a 100 weight.
- [00:21:22.343]That premium was $6.82 more or less per 100 weight,
- [00:21:26.471]$4 below that at 146
- [00:21:29.300]you could have bought a put option at 5.075.
- [00:21:33.520]It's a little over $5 and then at 142 you could have bought
- [00:21:37.480]a put option at 3.775.
- [00:21:40.630]So what does that mean?
- [00:21:42.239]That means you would pay that price upfront
- [00:21:44.479]that premium price upfront, and when it gives you the option
- [00:21:47.830]between now and the end of October
- [00:21:50.094]to sell a futures contract at those prices.
- [00:21:52.320]So if prices were to fall,
- [00:21:54.957]then those strike prices would put you in the money
- [00:21:58.221]with the put option and it would gain intrinsic value.
- [00:22:01.876]And you could cash in that intrinsic value at any time
- [00:22:05.241]by basically exercising the put
- [00:22:07.779]and then exercising the round turn trade
- [00:22:11.123]on the board of trade with that futures contract
- [00:22:14.470]that you purchase or that you sold.
- [00:22:17.635]Okay, there is a commission
- [00:22:19.500]attached to that round turn trade, but that's usually
- [00:22:22.710]you know again you know that up front and they tell you that
- [00:22:25.500]when you find out what the premium is to go with it
- [00:22:29.020]to actually purchase these options through your broker.
- [00:22:34.335]So here's one cashed out to give you an example
- [00:22:36.406]using our previous numbers, we have a put option at 150,
- [00:22:43.280]we paid 6.825 for that option set $3,412.50
- [00:22:47.960]that we'd have to pay up front to purchase that put option
- [00:22:51.082]which is the right to sell a futures contract at 150.
- [00:22:55.750]It's a futures contract ends up at 144.30
- [00:22:58.059]like we had in our early example.
- [00:23:00.209]The intrinsic value of that put option is $5.70
- [00:23:02.683]a 100 weight.
- [00:23:05.120]So then we could go ahead and exercise that option,
- [00:23:08.370]collect that $5.70 a 100 weight profit out of that
- [00:23:11.077]round turn trade.
- [00:23:13.113]If we subtract off what we paid for the put option,
- [00:23:15.621]we actually ended up with a negative gain here,
- [00:23:18.301]$1.125 per 100 weight.
- [00:23:22.439]So slight, we didn't quite make up all of our premium
- [00:23:27.364]that we paid out there
- [00:23:28.650]and we still would have a little commission to pay
- [00:23:31.100]on top of that so this one, even though we were
- [00:23:34.560]able to protect some downside risk with this put option
- [00:23:37.840]we actually lost money on it in the long run
- [00:23:40.198]but the idea of buying it is as prices would go
- [00:23:42.916]lower and lower and lower, that 570 would get
- [00:23:45.813]higher and higher and higher and eventually it would offset.
- [00:23:49.581]We don't have to go very far before it offsets
- [00:23:52.190]dollar for dollar with our actual change in prices.
- [00:23:57.910]So again, you're likely to receive a lower cash price
- [00:24:01.879]in the local market
- [00:24:02.827]as reaction to this lower market condition.
- [00:24:06.480]On the upside, if the futures contract settles at 155,
- [00:24:09.621]your option is worthless 'cause there's no reason to buy
- [00:24:12.780]or sell a futures option at 150, if you gotta turn around
- [00:24:15.020]and buy one at 155, so you would let it expire.
- [00:24:17.956]You're out that $6.82 a 100 weight or $3,400
- [00:24:25.040]that's upfront cost and it's gone
- [00:24:27.930]but you hope gon offset that in your local market
- [00:24:30.910]by getting a higher cash market price
- [00:24:33.610]and reaction to these higher prices.
- [00:24:35.911]So the nice thing about put options is upfront
- [00:24:39.307]the max you can lose is what you pay for them that $3,412.50
- [00:24:45.360]and if prices go haywire, this will compensate you
- [00:24:49.584]dollar for dollar without far, it drops below that
- [00:24:54.060]option price, that strike price that you have set
- [00:24:57.080]and you'll be able to recoup
- [00:24:58.380]some of those losses here in the CME exchange.
- [00:25:01.070]If prices go higher, you just let it expire
- [00:25:05.530]and hopefully benefit from it in the local cash market.
- [00:25:10.225]So, which would you choose among these?
- [00:25:12.420]When I offered these choices to people out,
- [00:25:14.720]when I do programs,
- [00:25:16.360]I typically see a few people
- [00:25:18.100]that wanna buy that at the money put
- [00:25:19.910]and pay that extra premium.
- [00:25:21.640]Most people are over when a protected portion of that price
- [00:25:25.232]so they wanna take a little bit of a discount on the premium
- [00:25:27.570]and only protect a portion of that.
- [00:25:29.850]Very seldom note, do they go very far below.
- [00:25:32.400]So this is very typical if I offer choices like that out
- [00:25:34.877]in the public that I'll see about a one in four,
- [00:25:38.430]take it at the money and the rest take it
- [00:25:40.610]slightly below that.
- [00:25:44.130]The last thing I'll mention is a basis contract.
- [00:25:46.153]This is what I mentioned is a formula pricing contract.
- [00:25:48.830]When you hear that term, this is most commonly used
- [00:25:52.440]with fed cattle, where a feed lot will contract
- [00:25:55.000]with a processor and agree on a price that is
- [00:25:59.380]x number of dollars above or below
- [00:26:02.000]whatever that fed cattle contract is trading at
- [00:26:04.510]on the board of trade.
- [00:26:06.020]So it establishes that basis
- [00:26:07.349]between the futures contract price
- [00:26:10.600]and the cash sale transaction physically taking place
- [00:26:13.573]between the seller and the buyer.
- [00:26:22.260]So with that, I'll end there with this episode.
- [00:26:25.310]And then next episode, we'll tackle LRP insurance
- [00:26:29.635]with which works a lot like a put option.
The screen size you are trying to search captions on is too small!
You can always jump over to MediaHub and check it out there.
Log in to post comments
Embed
Copy the following code into your page
HTML
<div style="padding-top: 56.25%; overflow: hidden; position:relative; -webkit-box-flex: 1; flex-grow: 1;"> <iframe style="bottom: 0; left: 0; position: absolute; right: 0; top: 0; border: 0; height: 100%; width: 100%;" src="https://mediahub.unl.edu/media/15027?format=iframe&autoplay=0" title="Video Player: Livestock Marketing - Cash markets versus futures and options" allowfullscreen ></iframe> </div>
Comments
0 Comments