Buying Live Cattle Call Options to Profit from a Rise in Live Cattle Prices

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Contents

Buying Live Cattle Call Options to Profit from a Rise in Live Cattle Prices

If you are bullish on live cattle, you can profit from a rise in live cattle price by buying (going long) live cattle call options.

Example: Long Live Cattle Call Option

You observed that the near-month CME Live Cattle futures contract is trading at the price of USD 0.8445 per pound. A CME Live Cattle call option with the same expiration month and a nearby strike price of USD 0.8400 is being priced at USD 0.0600/lb. Since each underlying CME Live Cattle futures contract represents 40000 pounds of live cattle, the premium you need to pay to own the call option is USD 2,400.

Assuming that by option expiration day, the price of the underlying live cattle futures has risen by 15% and is now trading at USD 0.9712 per pound. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying live cattle futures at the strike price of USD 0.8400. This means that you get to buy the underlying live cattle at only USD 0.8400/lb on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying live cattle futures at the market price of USD 0.9712 per pound, resulting in a gain of USD 0.1312/lb. Since each CME Live Cattle call option covers 40000 pounds of live cattle, gain from the long call position is USD 5,248. Deducting the initial premium of USD 2,400 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,848.

Long Live Cattle Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 0.9712/lb – USD 0.8400/lb) x 40000 lb
= USD 5,248
Investment = Initial Premium Paid
= USD 2,400
Net Profit = Gain from Option Exercise – Investment
= USD 5,248 – USD 2,400
= USD 2,848
Return on Investment = 119%

Sell-to-Close Call Option

In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the live cattle option sale will be equal to it’s intrinsic value.

Learn More About Live Cattle Futures & Options Trading

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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. ]

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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. ]

Buying Feeder Cattle Call Options to Profit from a Rise in Feeder Cattle Prices

If you are bullish on feeder cattle, you can profit from a rise in feeder cattle price by buying (going long) feeder cattle call options.

Example: Long Feeder Cattle Call Option

You observed that the near-month CME Feeder Cattle futures contract is trading at the price of USD 0.9520 per pound. A CME Feeder Cattle call option with the same expiration month and a nearby strike price of USD 0.9500 is being priced at USD 0.0600/lb. Since each underlying CME Feeder Cattle futures contract represents 50000 pounds of feeder cattle, the premium you need to pay to own the call option is USD 3,000.

Assuming that by option expiration day, the price of the underlying feeder cattle futures has risen by 15% and is now trading at USD 1.0950 per pound. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying feeder cattle futures at the strike price of USD 0.9500. This means that you get to buy the underlying feeder cattle at only USD 0.9500/lb on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying feeder cattle futures at the market price of USD 1.0948 per pound, resulting in a gain of USD 0.1450/lb. Since each CME Feeder Cattle call option covers 50000 pounds of feeder cattle, gain from the long call position is USD 7,250. Deducting the initial premium of USD 3,000 you paid to buy the call option, your net profit from the long call strategy will come to USD 4,250.

Long Feeder Cattle Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 1.0950/lb – USD 0.9500/lb) x 50000 lb
= USD 7,250
Investment = Initial Premium Paid
= USD 3,000
Net Profit = Gain from Option Exercise – Investment
= USD 7,250 – USD 3,000
= USD 4,250
Return on Investment = 142%

Sell-to-Close Call Option

In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the feeder cattle option sale will be equal to it’s intrinsic value.

Learn More About Feeder Cattle Futures & Options Trading

You May Also Like

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. ]

Cattle Trade Compendium – Everything You Need To Know In 2020

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Last Updated on March 26, 2020

Why Are Live Cattle Valuable?

Live cattle are full-grown cattle that have reached the necessary weight for slaughter. Cattle typically get slaughtered for meat and other by-products when they reach a weight of between 1,200 and 1,400 pounds, but this can vary.

For example, in 2020, the average, live federally inspected slaughter weight in the United States was approximately 1,384 pounds.

The beef industry is a global industry with an economic impact in the trillions of dollars. Beef production creates millions of jobs including suppliers, distributors and retailers. Ultimately, live cattle produce the beef and by-products consumed around the globe.

What is the Difference Between Feeder Cattle and Live Cattle?

Livestock traders distinguish between two types of cattle – feeder cattle and live cattle. The difference between these two commodities is the stage of the production cycle.

Feeder cattle are weaned calves that have reached a weight of between 600 and 800 pounds. At this point, feeder cattle are put in a feedlot where they consume a high-energy feed diet consisting mainly of corn and other grains. Feeder cattle typically need to gain more than 500 pounds before they reach slaughter weights, so corn prices have a big impact on feeder cattle prices.

Live cattle, on the other hand, are ‘finished’ products that are ready for sale to slaughterhouses. Supply and demand factors for beef typically play the biggest role in determining live cattle prices.

How Do Ranchers Produce Live Cattle?

Production of live cattle begins with breeding cows (females) with bulls (males) either naturally or with artificial insemination (A.I.). Cows bred in the summer will produce calves in the spring.

A natural breeding process generally requires one bull for each 20 to 25 cows. Many producers prefer A.I. because they can better control the genetics of the calves.

Ranchers allocate a certain amount of acres of pasture or grazing land for each cow and its calf offspring. This is known as the stocking rate, and it varies from region to region based on weather conditions and maintenance procedures.

In the United States –the top cattle-producing nation in the world – the stocking rate can be as low as five acres per cow-calf pair in high precipitation regions of the East to 150 acres in dry, arid regions of the West and Southwest.

Cows Grazing – Image via Pixabay

A group of cows on a ranch is called a herd. Each cow generally gives birth to one calf, although some may occasionally produce twins. Not all cows conceive; weather, disease and nutrition can all affect conception rates.

Each year ranchers typically cull about 15 to 25% of the cows in their herd and send them to slaughter. The most common reasons for culling a cow include:

  1. Failure to reproduce
  2. Advanced age
  3. Bad teeth
  4. Drought conditions
  5. High feed costs

Once the calves are born, a certain number of females are held back to replace the cows that are culled. The remaining calves are raised for eventual slaughter. The timeline for raising cattle is as follows:

  1. First six months: Calves remain with the cow and receive their initial nutrition from nursing. Over time, ranchers supplement this nutrition with grass feeding and eventually with grain.
  2. Six to eight months of age: Calves typically weight 500 to 600 pounds at this stage. Ranchers wean the calf from the cow. Some very heavy calves go directly into feedlots, but most pass through stocker operations.
  3. Stocker operations: Calves get fed on summer grass, winter wheat or some other roughage until they reach the weight of 600 to 800 pounds, which is when they become feeder cattle. This phase generally lasts between six to 10 months.
  4. Feedlot: A rancher then has three options:
    1. Continue to raise the cattle on the rancher’s property until they reach the designated weight for slaughter
    2. Send the cattle to a commercial feedlot. A rancher would retain ownership of the cattle while the commercial feedlot feeds them.
    3. Sell the feeder cattle to another rancher or feedlot operation.

Feeder cattle receive high-energy feed to promote weight gain. They are usually either steers (castrated males) or heifers (females that have not given birth). Cows (females that have given birth) and bulls (sexually intact males) generally are kept for production and not placed in feedlots.

Once the cattle reach slaughter weight, they are sold as live cows either directly to a packer or through an auction. Packers slaughter the live cows and sell all of the meat and by-products from the animals.

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  • Binomo
    Binomo

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