Recently, I had a number of clients involved in a futures spread in the live cattle market. The idea behind the trade was to get long the cattle market heading into the summer by buying in the front month and selling in the back month – specifically, they were buying June Live Cattle and simultaneously selling October live cattle.
This was a trade that most of my clients got involved in on April 19, 2012.
On April 24, 2012, an event occurred that significantly affected the price of cattle. The U.S. Department of Agriculture confirmed that a case of Mad Cow Disease was found in a dairy cow in central California. Officials reported that the deadly brain-wasting illness, known as bovine spongiform encephalopathy, was present in the cow. As a result, the price of live cattle closed at a nine-month low on fears that the largest foreign buyers of U.S. beef – Mexico, Canada, Japan and South Korea – would stop importing American meat.
The case turned out to be an isolated incident, found only in a single cow, and prices bounced back the following day.
Spreads vs Outright Futures Contracts
With this rare occurrence, how did the news and movement in the market that day affect the original spread? What if, instead of using a futures spread to get long the cattle market, my clients simply bought the June contract outright by itself?
On April 24th, the June Live Cattle contract opened at 114.725 and closed at 111.575 which is a $3.15 move, equivalent to a $1,575.00 move in a trading account for every one June Live Cattle Futures contract. Had someone been simply long one June Live Cattle contract coming into the trading session that day, they would have been down $1,575.00.
Now let’s take a look at what happened to my clients that had on the futures spread where they bought June Live Cattle but then simultaneously sold October Live cattle. That spread opened at 9.825 on April 24, 2012 and closed at 9.875, which was a difference of .05 cents, or $25.00, in a trading account for every one June/October Live Cattle spread they had coming into that trading session.
My point is that both ideas, buying June Live cattle by itself, and buying June Live Cattle while selling October Live Cattle simultaneously as a spread, were trying to accomplish the same goal. However, by using a futures spread, market volatility was significantly reduced that day when the overall market made a huge move down.
This is an example of how futures spreads trading can help traders with their risk and potentially reduce market volatility. If you’d like more information, please contact us at 800.800.3840.