CME Group Futures, Options, and the Cattle Crush September 12, 2017 Joanna Litchfield Agricultural Business Line Management 2017 CME Group. All rights reserved. Disclaimer Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract's value is required to trade, it is possible to lose more than the
amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. All references to options refer to options on futures. Any research views expressed those of the individual author and do not necessarily represent the views of the CME Group or its affiliates. The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. All examples are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official rulebook of the organizations. Current rules should be consulted in all cases concerning contract specifications CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. All other trademarks are the property of their respective owners.
Copyright 2017 CME Group. All rights reserved. 2017 CME Group. All rights reserved. Chicago Merchantile Exchange (CME) Chicago Board of Trade (CBOT)
New York Merchantile Exchange (NYMEX) Commodity Exchange (COMEX) Kansas City Board of Trade (KCBT)
2017 CME Group. All rights reserved. How CME Group Evolved Over Time From unstructured street corners, to a formalized trading location, to a global marketplace. 2017 CME Group. All rights reserved. 4 This development allowed more people equal
access to prices and liquidity through a central limit order book. 2017 CME Group. All rights reserved. 5 What are Futures? Legally binding agreement to accept delivery of or make delivery of a standardized quantity and quality of a commodity to a standardized place during a standardized
time period for a price discovered in an organized futures exchange. 2017 CME Group. All rights reserved. 6 Example of a Futures Contract CME Group offers many agricultural commodity contracts. 2017 CME Group. All rights reserved. 7
Options on Futures Contract between two parties that conveys a RIGHT but not an obligation to buy or sell a specific commodity at a specific price within a specific time period for a premium. Buy a Call: Right to Buy Futures Buy a Put: Right to Sell Futures 2017 CME Group. All rights reserved. 8
Tools to Manage Price Risk Futures Allow you to lock in a futures price level Simple, requires margin deposit Options on Futures Price protection with flexibility Benefit from upside or downside Analogous to insurance, long options does not margin deposits require
2017 CME Group. All rights reserved. 9 Purpose of Futures and Options Futures provide three key functions: Price Discovery - Centralized place to price commodities Price Risk Management - Hedge with futures and options
Efficient Commodity Allocation - Nearby/Sell versus Future/Store 2017 CME Group. All rights reserved. 10 Price Discovery Futures provide transparency. Market for discovering price determined by buyers and sellers. CME Group publishes intraday and settlement prices at the market close for all our contracts.
Allows everyone in the cash industry farmers, processors, end users an idea of the current (and future!) values of these commodities. Go most places in the world and ask, Whats the Price of Corn? and most will tell you their price relative to Chicago. 2017 CME Group. All rights reserved. 11 Price Discovery Example The Great Chicago Flood. The Story of the 1992 Great Chicago Tunnel Flood and the Evansville Corn Rail Market.
Source: Chicago Tribune 2017 CME Group. All rights reserved. 12 Price Risk Management Futures provide a place to offset your risk. Futures Markets are used by agricultural market participants to hedge against adverse price movements. Cash price and futures price are highly correlated.
Futures effectively lock in prices you will pay or receive. Grower will sell futures, because if the price goes down he can buy back while processors will buy futures because if the price goes up they can sell them. 2017 CME Group. All rights reserved. 13 Price Risk Management Protecting your Profitability If You Are Not Hedging,
You are Speculating 2017 CME Group. All rights reserved. Managing Volatility 2017 CME Group. All rights reserved. 15 Efficient Commodity Allocation Futures provide a signal to farmers.
Unique to commodity markets, because they are products produced once annually that need to be allocated throughout an entire year. The price spreads between these different delivery months represents the return from storage. When supplies are sufficient, the spreads are wide, and the market pays warehouses and farmers to store. However, when supplies are tight, the market penalizes storage.
2017 CME Group. All rights reserved. 16 Beef Cattle Production 2017 CME Group. All rights reserved. 17 Using Futures The Cattle Crush
Two Primary Inputs: 1) Corn One Primary Output: 2) Feeder Cattle 1) Live Cattle Take a Long Position Take a Short Position 2017 CME Group. All rights reserved.
2017 CME Group. All rights reserved. 19 Cattle Crush Example Cattle Crush = (6 * Live Cattle) (3 * Feeder Cattle) (2 * Corn) On February 25, the closing prices for the specific contracts were as follows: August 2017 Live Cattle: $131.68/cwt April 2017 Feeder Cattle: $172.525/cwt May 2017 Corn: $4.6125/bu. This implies the following cattle crush:
Cattle Crush = (6*400*131.68) (3*500*172.525) (2 * 5000*4.6125) - Crush = $11,108/trade - or $0.278/cwt of live cattle (40k lb.) or $0.222/cwt of feeder cattle (50k lb.) 2017 CME Group. All rights reserved. 20 Cattle Crush 2017 CME Group. All rights reserved. 21
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