Self study guide to hedging with livestock futures and options - Hedging Using Futures - Price Protection for Cattle Producers

It was not unusual for many of them to open accounts with different brokers.

Collectively they had an incredibly important impact on the market. However, after approximately 15 years, this is no longer the case. Industry sources have it that many, if not most producers, have either closed their accounts, have an inactive account, or have scaled down on their trading activities.

On the basis of a study conducted stock options questions answers the Western Cape, this article will investigate the trend and try to determine the reasons for the decline. The role of Safex in the agricultural industry The South African government in general subscribes to a free market policy with regard to the South African grain and oilseeds industries.

A policy of minimum government intervention is applied. The industry therefore is largely self-regulatory.

The only licence currently issued for trading agricultural derivative products is in favour of the JSE, which operates a separate Commodity Division trading in agricultural commodities, among exchange traded fx options. It is thus important for the industry that the JSE operates a market where participation by all potential players is free, fair and transparent and that they have the support of core industry groups, including primary agriculture.

Should this be the case, the justification of a single commodity exchange for a relatively small country like South Africa makes economic sense. Alternatively, if there is a decline livestcok producer participation, it is important to determine what the reasons for this are.

Are there negative influences, or is it merely a natural evolvement of the market? It also holds secondary consequences for traders and agri-businesses and financiers whose clientele is taking on a different risk profile.

Commodity Derivatives

Data collection The primary data for this study was collected by means of a survey questionnaire containing both closed multiple choice and openended questions. The secondary data was collected through personal one-on-one interviews with brokers grain traders and agri-businesses.

Reasons for using the Western Cape as the case study The Western Cape is geographically isolated from the rest of South Africa since the Karoo separates the summer and winter rainfall production areas.

This makes defining sample boundaries easier and clearer.

The Western Cape crop production area and its stakeholders are thus in some way isolated from the rest of South Africa and it is for this reason that it was chosen as the sample area for this study. Unnecessary variables which could influence the results negatively could more easily be excluded from the sample and the data would therefore be much more accurate and easier oivestock obtain.

The Western Cape is the largest wheat production province in South Africa.

It also mainly produces wheat and to some extent barley in the Southern Cape, thus there are limited other crops that will influence the data and ultimately the results. Even the contribution of other farming enterprises such as livestock and deciduous fruits are limited in the wheat production areas.

Furthermore, the pricing mechanism in the Western Cape is different from the other provinces since it is a local surplus production area.

This is in contrast to the inland areas that are deficit areas. Thus gross income from wheat is typically less per ton and producers have to pay much closer attention to its pricing structure.

Analysis of surveyed data Feedback from the producer respondents are dealt with first, followed by that of the traders and agri-businesses.

Importance of wheat At first it was important to establish whether or not wheat plays qith important role in the Western Cape grain production areas.

Marketing and pricing strategy This question in the survey attempted to determine at which stage of the season the producer prices or sells which percentage of his wheat. The response indicated that roughly half of producers inadvertently hedge themselves by spreading seld risk evenly in the physical market throughout most of the year.

The supposition that can be made is that they do not need a formal Safex hedging strategy. Their pricing methods strive to obtain an average seasonal price.

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The other half are more inclined to focus on certain time periods, hoping to cherry-pick some better prices. Producers hedging directly on Safex This section dealt with the core of the survey.

The producer was first asked whether he currently has or whether he has ever had a Safex account. Their view was not quite supported by the traders and agri-businesses if factored in over all of the Western Cape.

This was done by establishing if there was an increase, decrease or no change in the active participation. Graph witg depicts the response. This was entirely supported by the traders and agri-businesses.

For example, the December live cattle contract will expire on December 30, Live cattle futures contracts are deliverable upon expiry. To remove the obligation to make or take delivery of cattle, the futures contract needs to be offset prior to expiry.

In fact, very few futures contracts are delivered upon, they are offset. Generally, the trading in futures contracts is not for the options trading otc of the physical commodity, but rather it is the trading of obligations. Complete contract specifications for live cattle and other futures contracts are provided on the CME Group website www.

There are basically two types of traders who participate in the futures market, hedgers and speculators. Hedgers produce or use i.

Speculators generally do not trade or use the physical commodity. They trade futures to profit from the price movement in the futures market.

Remember, for every seller there is a buyer and for every buyer there is a seller. There are two types of hedgers, a short hedger who wants to protect against a price decline and a long hedger who wants to protect against a price rise.

An example of a short hedger would be a cattle producer finishing cattle who wants to protect a future price against a potential decline. To start the hedge they would sell a live cattle futures contract.

An example of a long hedger would be a cattle producer who needs corn for feed and who wants to optiobs a future corn price against a potential increase.

To start the hedge he would buy a corn futures contract.

To hedge is to take a futures position that is equal and opposite to a position held in the cash market. The objective is to manage the risk of an adverse move in prices.

Hedging works because futures and cash prices both respond to the underlying forces of supply and demand. This means they amd tend to move together and in the same direction over time.

Also, the futures contract delivery provision or threat of delivery helps to ensure the futures ugide cash prices eventually move together. A short hedge provides protection against declining prices.

If prices had gone up in the above example, the value realized from the futures hedge would have declined but the cash price should have increased since the two prices generally move in the same direction over time not necessarily the same amount.

Description:Financing and Margin Costs of Hedging with Futures. .. This report presents a prefeasibility study of a rice futures market in the Association of .. commodity risk management markets (e.g., CBOT futures and options markets). South Africa were used as the hedging instrument, rather than futures contracts issued.

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