1 | THE CATTLE CRUSH AND REVERSE CRUSH WHAT IS THE CATTLE CRUSH? The cattle crush trade seeks to replicate the gross margin of a typical feedlot operation by calculating the spread between input costs and the output sale price. For a typical feedlot, the two primary inputs are feeder cattle and corn while the output is live cattle, which are sent to market once the feeding process ends. The long crush trade combines taking a long position in feeder cattle and corn with corresponding short positions in live cattle. The approximate ratio of corn, feeder cattle and live cattle therefore is as follows: 2 corn and 3 feeder cattle to 6 live cattle. Calculating the number of contracts to purchase in order to even all legs of the trade requires making some assumptions and it is not perfect. After all, we are talking about live animals that differ in terms of weight and speed at which they reach market weights. The cattle crush (and reverse cattle crush), or the cattle feeding spread, is a trade that is more familiar to feedlot risk managers than financial investors. However, going forward we propose that: • The cattle crush will continue to have commercial appeal for feedlot operators • The cattle crush presents a great investment opportunity for investors that are comfortable trading multi contract positions (spreads). In the past, the opportunity that this trade presents as a financial investment has been often overlooked or underappreciated. Livestock and feed markets have become much more volatile in recent years, and this has led to increased use of futures by hedgers and better opportunities for speculators. For hedgers, the trade closely mimics the natural dynamics of the cattle feeding industry and is used to minimize operational risk. For speculators, the trade presents significant variability, both intrinsic and seasonal, to make it an interesting investment opportunity. Furthermore, by spreading positions in feeder cattle and corn against live cattle, lowers the performance bond (margin) required to hold the outright positions. Bottom line: The ‘cattle crush’ trade merits further review given the historical potential of the trade and the margin efficiencies that can be achieved. For those market participants who regularly trade the cattle crush, the recent volatility in livestock and feed markets has made the last three months a particularly interesting period. The value of the spread jumped some 54% in a two- week period in January and then pulled back just as much in the last two weeks (see chart), underscoring the potential for profit in the current volatile market environment. THE CATTLE CRUSH AND REVERSE CRUSH: An Industry Hedging Tool And A Financial Investment Opportunity Cattle Crush: Aug 2014 Live Cattle 6 Aug ‘14 Live Cattle - 3 Apr ‘14 Feeder Cattle - 2 May ‘14 Corn Daily Closing Values for the Past Three Month All three legs of the trade have been impacted by both the short term drivers led by weather and retail demand as well as the long term undercurrent of a shrinking U.S. herd and expanding global demand for beef. Author: Len Steiner
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1 | THE CATTLE CRUSH AND REVERSE CRUSH
WHAT IS THE CATTLE CRUSH?
The cattle crush trade seeks to replicate the gross
margin of a typical feedlot operation by calculating the
spread between input costs and the output sale price.
For a typical feedlot, the two primary inputs are feeder
cattle and corn while the output is live cattle, which are
sent to market once the feeding process ends. The long
crush trade combines taking a long position in feeder
cattle and corn with corresponding short positions in
live cattle. The approximate ratio of corn, feeder cattle
and live cattle therefore is as follows: 2 corn and 3
feeder cattle to 6 live cattle. Calculating the number
of contracts to purchase in order to even all legs of the
trade requires making some assumptions and it is not
perfect. After all, we are talking about live animals that
differ in terms of weight and speed at which they reach
market weights.
The cattle crush (and reverse cattle crush), or the cattle
feeding spread, is a trade that is more familiar to feedlot
risk managers than financial investors. However, going
forward we propose that:
• The cattle crush will continue to have commercial
appeal for feedlot operators
• The cattle crush presents a great investment
opportunity for investors that are comfortable trading
multi contract positions (spreads).
In the past, the opportunity that this trade presents as
a financial investment has been often overlooked or
underappreciated. Livestock and feed markets have
become much more volatile in recent years, and this has
led to increased use of futures by hedgers and better
opportunities for speculators. For hedgers, the trade
closely mimics the natural dynamics of the cattle feeding
industry and is used to minimize operational risk. For
speculators, the trade presents significant variability, both
intrinsic and seasonal, to make it an interesting investment
opportunity. Furthermore, by spreading positions in feeder
cattle and corn against live cattle, lowers the performance
bond (margin) required to hold the outright positions.
Bottom line: The ‘cattle crush’ trade merits further review
given the historical potential of the trade and the margin
efficiencies that can be achieved.
For those market participants who regularly trade the
cattle crush, the recent volatility in livestock and feed
markets has made the last three months a particularly
interesting period. The value of the spread jumped some
54% in a two- week period in January and then pulled
back just as much in the last two weeks (see chart),
underscoring the potential for profit in the current volatile
market environment.
THE CATTLE CRUSH AND REVERSE CRUSH: An Industry Hedging Tool And A Financial Investment Opportunity
Cattle Crush: Aug 2014 Live Cattle 6 Aug ‘14 Live Cattle - 3 Apr ‘14 Feeder Cattle - 2 May ‘14 Corn
Daily Closing Values for the Past Three Month
All three legs of the trade have been impacted by both the
short term drivers led by weather and retail demand as
well as the long term undercurrent of a shrinking U.S. herd
and expanding global demand for beef.
Author: Len Steiner
2 | THE CATTLE CRUSH AND REVERSE CRUSH
The cattle crush spread for August 2014 Live Cattle, which is what we showed on page 1, may be calculated as follows:
S E A S O N A L T E N D E N C IE S A R E A C O M P O S IT E O F S O M E O F T H E M O R E C O N S IS T E N T C O M M O D IT Y F UT UR E S S E A S O N A L S T H A T H A VE O C C UR R E D O VE R T H E P A S T 15 Y E A R S . T H E R E A R E US UA L L Y UN D E R L Y IN G F UN D A M E N T A L C IR C UM S T A N C E S T H A T O C C UR A N N UA L L Y T H A T T E N D T O C A US E T H E F UT UR E S M A R K E T S T O R E A C T IN A S IM IL A R
D IR E C T IO N A L M A N N E R D UR IN G A C E R T A IN C A L E N D A R P E R IO D O F T H E Y E A R . E VE N IF A S E A S O N A L T E N D E N C Y O C C UR S IN T H E F UT UR E , IT M A Y N O T R E S UL T IN A P R O F IT A B L E T R A N S A C T IO N A S F E E S , A N D T H E T IM IN G O F T H E E N T R Y A N D L IQUID A T IO N M A Y IM P A C T O N T H E R E S UL T S . N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T A N Y A C C O UN T H A S IN T H E P A S T O R WIL L IN T H E F UT UR E A C H IE VE P R O F IT S UT IL IZ IN G T H E S E S T R A T E G IE S . N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T P R IC E P A T T E R N S WIL L
R E C UR IN T H E F UT UR E . H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S H A VE M A N Y IN H E R E N T L IM IT A T IO N S , S O M E O F WH IC H A R E D E S C R IB E D B E L O W. N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T A N Y A C C O UN T WIL L O R IS L IK E L Y T O A C H IE VE P R O F IT S O R L O S S E S S IM IL A R T O T H O S E S H O WN . IN F A C T , T H E R E A R E F R E QUE N T L Y S H A R P D IF F E R E N C E S
B E T WE E N H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S A N D T H E A C T UA L R E S UL T S S UB S E QUE N T L Y A C H IE VE D B Y A N Y P A R T IC UL A R T R A D IN G P R O G R A M . O N E O F T H E L IM IT A T IO N S O F H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S IS T H A T T H E Y A R E G E N E R A L L Y P R E P A R E D WIT H T H E B E N E F IT O F H IN D S IG H T . IN A D D IT IO N , H Y P O T H E T IC A L
T R A D IN G D O E S N O T IN VO L VE F IN A N C IA L R IS K , A N D N O H Y P O T H E T IC A L T R A D IN G R E C O R D C A N C O M P L E T E L Y A C C O UN T F O R T H E IM P A C T O F F IN A N C IA L R IS K IN A C T UA L T R A D IN G . F O R E X A M P L E , T H E A B IL IT Y T O WIT H S T A N D L O S S E S O R A D H E R E T O A P A R T IC UL A R T R A D IN G P R O G R A M IN S P IT E O F T R A D IN G L O S S E S A R E M A T E R IA L P O IN T S
WH IC H C A N A L S O A D VE R S E L Y A F F E C T A C T UA L T R A D IN G R E S UL T S . T H E R E A R E N UM E R O US O T H E R F A C T O R S R E L A T E D T O T H E M A R K E T S IN G E N E R A L O R T O T H E IM P L E M E N T A T IO N O F A N Y S P E C IF IC T R A D IN G P R O G R A M WH IC H C A N N O T B E F UL L Y A C C O UN T E D F O R IN T H E P R E P A R A T IO N O F H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S
A N D A L L O F WH IC H C A N A D VE R S E L Y A F F E C T A C T UA L T R A D IN G R E S UL T S . R E S UL T S N O T A D J US T E D F OR C O M M IS S IO N A N D S L IP P A G E .
Average Profit on Winning Trades Winners
Average Loss on Trades Losers
Average Net Profit Per Trade Total trades
Buy Apr Feeder Cattle(CME) / Buy May Corn(CBOT) / Sell 2 Aug Live Cattle(CME)Enter on approximately 03/08 - Exit on approximately 04/06
Percentage Correct
7 | THE CATTLE CRUSH AND REVERSE CRUSH
A Reverse Cattle Crush Trading Strategy: Calculations Made by MRCI (Moore Research Center Inc)
S E A S O N A L T E N D E N C IE S A R E A C O M P O S IT E O F S O M E O F T H E M O R E C O N S IS T E N T C O M M O D IT Y F UT UR E S S E A S O N A L S T H A T H A VE O C C UR R E D O VE R T H E P A S T 15 Y E A R S . T H E R E A R E US UA L L Y UN D E R L Y IN G F UN D A M E N T A L C IR C UM S T A N C E S T H A T O C C UR A N N UA L L Y T H A T T E N D T O C A US E T H E F UT UR E S M A R K E T S T O R E A C T IN A S IM IL A R
D IR E C T IO N A L M A N N E R D UR IN G A C E R T A IN C A L E N D A R P E R IO D O F T H E Y E A R . E VE N IF A S E A S O N A L T E N D E N C Y O C C UR S IN T H E F UT UR E , IT M A Y N O T R E S UL T IN A P R O F IT A B L E T R A N S A C T IO N A S F E E S , A N D T H E T IM IN G O F T H E E N T R Y A N D L IQUID A T IO N M A Y IM P A C T O N T H E R E S UL T S . N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T A N Y A C C O UN T H A S IN T H E P A S T O R WIL L IN T H E F UT UR E A C H IE VE P R O F IT S UT IL IZ IN G T H E S E S T R A T E G IE S . N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T P R IC E P A T T E R N S WIL L
R E C UR IN T H E F UT UR E . H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S H A VE M A N Y IN H E R E N T L IM IT A T IO N S , S O M E O F WH IC H A R E D E S C R IB E D B E L O W. N O R E P R E S E N T A T IO N IS B E IN G M A D E T H A T A N Y A C C O UN T WIL L O R IS L IK E L Y T O A C H IE VE P R O F IT S O R L O S S E S S IM IL A R T O T H O S E S H O WN . IN F A C T , T H E R E A R E F R E QUE N T L Y S H A R P D IF F E R E N C E S
B E T WE E N H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S A N D T H E A C T UA L R E S UL T S S UB S E QUE N T L Y A C H IE VE D B Y A N Y P A R T IC UL A R T R A D IN G P R O G R A M . O N E O F T H E L IM IT A T IO N S O F H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S IS T H A T T H E Y A R E G E N E R A L L Y P R E P A R E D WIT H T H E B E N E F IT O F H IN D S IG H T . IN A D D IT IO N , H Y P O T H E T IC A L
T R A D IN G D O E S N O T IN VO L VE F IN A N C IA L R IS K , A N D N O H Y P O T H E T IC A L T R A D IN G R E C O R D C A N C O M P L E T E L Y A C C O UN T F O R T H E IM P A C T O F F IN A N C IA L R IS K IN A C T UA L T R A D IN G . F O R E X A M P L E , T H E A B IL IT Y T O WIT H S T A N D L O S S E S O R A D H E R E T O A P A R T IC UL A R T R A D IN G P R O G R A M IN S P IT E O F T R A D IN G L O S S E S A R E M A T E R IA L P O IN T S
WH IC H C A N A L S O A D VE R S E L Y A F F E C T A C T UA L T R A D IN G R E S UL T S . T H E R E A R E N UM E R O US O T H E R F A C T O R S R E L A T E D T O T H E M A R K E T S IN G E N E R A L O R T O T H E IM P L E M E N T A T IO N O F A N Y S P E C IF IC T R A D IN G P R O G R A M WH IC H C A N N O T B E F UL L Y A C C O UN T E D F O R IN T H E P R E P A R A T IO N O F H Y P O T H E T IC A L P E R F O R M A N C E R E S UL T S
A N D A L L O F WH IC H C A N A D VE R S E L Y A F F E C T A C T UA L T R A D IN G R E S UL T S . R E S UL T S N O T A D J US T E D F OR C O M M IS S IO N A N D S L IP P A G E .
Average Profit on Winning Trades Winners
Average Loss on Trades Losers
Average Net Profit Per Trade Total trades
Buy 2 Feb Live Cattle(CME) / Sell Sep Feeder Cattle(CME) / Sell Dec Corn(CBOT)Enter on approximately 07/02 - Exit on approximately 07/27
Percentage Correct
8 | THE CATTLE CRUSH AND REVERSE CRUSH
APPENDIX 2
CURRENT CATTLE & BEEF MARKETFUNDAMENTALS
The perfect storm developed in the cattle and beef markets during late December and January. An air pocket in supply that
most market participants failed to see coming began to develop shortly after New Year’s Day. Holiday-shortened kill schedules
combined with some nasty winter weather to greatly restrict the availability of beef in the wholesale market. At the same time,
beef buyers who were anticipating the normal seasonal lull in pricing after the holidays had drawn inventories down, expecting
to buy product cheaper after the first of the year. The final piece of the puzzle belonged to consumers who hit retail stores
aggressively to stock up in advance of approaching winter weather. The result was a strong demand surge that coincided with
very short supply and sent both cattle and beef prices to all-time record highs.
Chart 1 illustrates what happened to the value of the Choice
beef cutout during January as this perfect storm played out.
Now that buyers have had a chance to adjust and develop
alternatives, the cutout has retreated closer to “normal”
levels and cash cattle prices, which peaked at $150, are
back down to $142. However, the events of January are still
reverberating through the market and many participants are
still on edge. Cattle feeders were the main beneficiaries of
the perfect storm as the sharp jump in cattle prices helped
to lift their margins back into the black after many months
once again. Packers face their own overcapacity issues
and will continue to struggle financially until more plants
shut down. The recent announcement that National Beef
will stop slaughtering at its Brawley, California plant in early
April may help to a small degree, but Informa believes that
at least one, and possibly two, more large slaughter plants
need to shutter before packer margins can consistently
move into positive territory.
Chart 4 shows that kills have been well below last year
since late summer and the Informa forecast is for more
of the same over the next couple of months. It will take
a while for all aspects of the market to return to some
semblance of equilibrium following the January shock, but
the general tone of the market should be one of struggle:
feeders struggling to keep their head above water, packers
struggling to right their ship, and retailers and consumers
struggling with high beef prices. While Informa’s forecast
looks for some slight softening of cattle prices in the next
few weeks, the weather remains a wild card and could easily
goose the market higher with little notice. That said, the
longer-term picture is quite bullish, driven by shrinking cattle
supplies in the face of an improving domestic economy.
In the interim, look for packers to keep pulling back on the throttle with respect to kills and they will likely maintain this
strategy as long as it takes to raise beef prices and/or lower cattle prices. Last week’s estimated slaughter of 539,000 head
was the smallest non-holiday kill week in modern times.
It is also very likely that the rally in wholesale beef prices will result in retail stores raising prices to consumers and that
will have a dampening effect on consumption. In the short-run, cattle prices may be buoyed by continued harsh weather,
but within a few weeks that will be behind us and prices could drift lower. Packers certainly have an incentive to keep the
pressure on cattle prices.
Chart 3: Estimated Net Packer Margin
-80
-60
-40
-20
0
20
40
60
80
7/3/
13
7/17
/13
7/31
/13
8/14
/13
8/28
/13
9/11
/13
9/25
/13
10/9
/13
10/2
3/13
11/6
/13
11/2
0/13
12/4
/13
12/1
8/13
1/1/
14
1/15
/14
1/29
/14
2/12
/14
$ Pe
r Hea
d
Chart 4: Weekly Cattle Slaughter, YOY Comparison
(85)
(65)
(45)
(25)
(5)
15
35
55
75
95
430
480
530
580
630
680
02/1
3/13
02/2
7/13
03/1
3/13
03/2
7/13
04/1
0/13
04/2
4/13
05/0
8/13
05/2
2/13
06/0
5/13
06/1
9/13
07/0
3/13
07/1
7/13
07/3
1/13
08/1
4/13
08/2
8/13
09/1
1/13
09/2
5/13
10/0
9/13
10/2
3/13
11/0
6/13
11/2
0/13
12/0
4/13
12/1
8/13
01/0
1/14
01/1
5/14
01/2
9/14
02/1
2/14
02/2
6/14
03/1
2/14
03/2
6/14
Diff
eren
ce (T
hou
Hd)
Thou
sand
Hea
d
Date
Current Yr Minus Last Yr Current Yr Last Yr Forecast
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contained herein is accurate or complete and it should not be relied upon as such.