Professional Options Trader (Core Trading Course)

Additionally, the example uses several cash and futures price changes to demonstrate what circumstances bring about different hedging outcomes. Assume it is late fall and you have placed 200 head of steers in the feedlot under a retained ownership program. These cattle should be ready for market as slaughter steers in early to mid-May. Currently, the June live cattle futures contract is trading for 74.00 cents and the normal May basis is –1.00 cents (or 1.00 under).

The June futures contract is the appropriate contract month for this hedge. June is the closest available contract month to the expected May sale date with no danger of expiration (called the nearby futures contract). The hedge would be placed in early November by taking a short position on June live cattle.

The number of contracts would be enough to represent 200 head of finished steers (6 contracts at 40,000 pounds each assuming 1200 pounds per steer). The futures contracts will be offset and the cattle sold on the cash market in early to mid-May. The expected price is 73.00 cents (the June futures price of 74.00 cents plus an expected basis of –1.00).

The following examples (A through D) summarize outcomes of this hedge under four different circumstances.

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