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Ridgway, IL | Garvo, this is my understanding of the cattle delivery system:
Imagine a feedlot of a size that it keeps 10k head of cattle placed against each month of the year.
10k to finish sep, 10k oct, 10k nov, 10k dec
20k hedged oct futures 20k hedged dec
Sep rolls around, the cattle placed against sep are 1350lb. The feeder sees oct dec go from 4$ carry to dec, to 6. He thinks, I’m gonna feed these a little longer...
Oct rolls around, carry is still 6$ to dec. dec-feb at 5$.
The feedlot thinks, I can make good money by rolling these hedges against cattle placed against sep and oct from oct futures to dec and feed them another 60days. That would be even sweeter if I had to feed them less than 60 days and could earn more than 6$ carry.
Chapter 2
How can I make spreads wider? And what is the right value for spreads to trade at?
I think we can all agree, the cash market has been trading at a basis from -1 to -2oct futures for the past 2 weeks.
The feedlot who makes delivery get a zero basis right? Because he gets par futures. The thing that might go un noticed, is the seller/maker of delivery has some costs associated with the process of tendering delivery. Weighing, grading, yardage. Those may seem like small things, but remember a futures contract is only 40k lb. so if the guy who tenders delivery has associated cost of 400$ per load, his effective net basis is -1. This is an important number, we will call it delivery value equivalent. Or, dve. It’s important to note that is the sellers dve.
The buyer/long position may also have some costs associated with executing a delivery transaction on his end which means his effective basis on the long side might be above par/0.
If, the cash market is trading at -2, a feedlot tenders delivery, that ticket is assigned to a long (assume its a packer) and he says “why do I want this load of cattle that is gonna cost me +.5, when I can buy cattle in the cash market at -2?” ... well he would get fired by his boss if he did that, so he retenders delivery and let’s the next guy deal with it. It’s like a game of hot potatoe. This forces out nearby long positions which is what drives the spreads wider.
This is a big win for the feedlot, because they presumably delivered only a small % of their inventory, but reap the rewards of the wider spreads on all their remaining inventory by rolling all their hedges out.
Chapter 3.
But does the stopper always retender?? The answer is no. But I will say this is where I get a little foggy on some of the rules of cattle futures. In theory, there are 2 situations where the stopper wouldn’t retender. 1 of those situations is if the effective basis of demanding delivery on those tickets would net a lower cost of cattle than the cash market is trading. 2. Would be if the spread to the next futures month was wide enough that it covers the cost of feeding the animal to the next delivery month, when presumably basis will converge once again. That would be known as full carry. With the added wrinkle that a long position retenderimg a delivery has to pay a 1$ Penalty to redeliver, that means sometimes he may just hold on to a certificate because by the time he redelivers and pays the penalty it makes his effective basis the same as what the cash market is trading
So if you look at today’s market, I say the following:
1. I sort of wonder about the guy making delivery... 750 head seems like such a small number. Usually, in a delivery situation, you might want to use a bit of psychology by delivering an amount that would scare off your casual long position
2. With oct/dec trading at 6+$ carry for only 37 days to dec... that seems to me like it would easily provide a good profit to anyone who wanted to simply roll their hedges to dec
3. Because that spread is so wide already, and the cash market is so near delivery value equivalent basis anyway... the seller is really taking a chance that the long position will just say stop I’ll tske your cattle.
So it seems silly to be making delivery, but I’ve never been in the heat of it and like a lot of things the devils in the details.
Chapter 4
What now? Remember our feedlot? Now all the cattle that were placed against sep have another 60 days on them and weigh 1480 and basis was established at -1 for nov to avoid 1050+ dock and they become available 7 days from today to the packer. But the market is still set up the same so the feedlots working on getting hedges for cattle placed against nov/dec rolled out to feb.
In markets like this, I think the fat cattle will come in waves depending on the basis values they were offered at the time they elected to roll their futures positions.
This is why I believe we are just getting ready to see carcass weights ramp way up, cheap feed to go along with it. Did you know that funds currently hold an all time record long position in feeder cattle? This is why they seem so over valued, and also why I believe the feedlot is content to not swap their fats for new feeders. This is backing up feeders in the country. The market is currently saying jan and nov feeders are with the same, and that is as wrong as wrong can be. | |
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explain cattle delivered to cme at West Point,Neb
