December 12, 2003

 

Market Advisor: Limit Up, Limit Down -- Cattle Futures Remain Volatile

By Tim Petry, Livestock Marketing Economist
NDSU Extension Service

Both Chicago Mercantile Exchange (CME) live cattle and feeder cattle futures market prices have increased significantly this year. The December 2003 live cattle contract increased from less $70 per hundredweight (cwt.) in March to just under $100/cwt. in early December, a $30/cwt. movement. By mid-December, the contract price had declined to about $94/cwt.

The January 2004 feeder cattle futures contract moved from under $80/cwt. in March to over $102/cwt. in early December. By mid-December, the price had declined to about $95/cwt.

With the higher price levels in the last several months, price volatility has increased in the markets. Limit movements both up and down of $1.50/cwt. per day, once rare, have become common.

For seven straight days in early October, the nearby October live cattle futures contract increased the $1.50/cwt. limit. During the month of October, the October contract traded the daily limit on 13 out of 23 trading days. The market was up the limit on nine occasions and down the limit four times.

Due to the unprecedented number of limit moves, the CME raised the daily limit for live cattle on Oct. 15.

Under the new rules, the $1.50/cwt. limit above or below the previous day?s settlement prices is in effect unless consecutive limit movements occur. If either of the two contracts nearest to expiration in the even month cycle -- February, April, June, August, October and December settles at the limit for two successive trading days, the price limit is raised to $3/cwt. for all contracts. This includes the serial (odd) month contracts of January, March, May, July, September and November.

The CME initiated trading in the serial months beginning with the May 2003 contract. Trading is only allowed for about the last 120 days before expiration, compared to the approximately one-year trading of the even month contracts. Expiration occurs on the last trading day of the contract month. Serial month trading was instituted to reduce basis risk for cattle marketed in the serial months that previously could only be hedged in the even month contracts.

When either of the two nearby even month contracts settles at the $3 limit for two consecutive days, the limit for all contracts increases to $5/cwt. If the daily limit is $5 and neither of the two nearby even month contracts settles at the limit, the limit reverts to $3 for the next trading day. If the daily trading limit is $3 and neither of the two nearby contracts settles at the limit, it reverts back to $1.50.

Live cattle futures have settled at the $3 limit only once, on Oct. 16, when the October contract was down $3/cwt. The previous day, Oct. 15, was the first time the $5 daily limit was in effect and the market increased $2.60, so on Oct. 16 the limit was lowered to $3.

Most recently, the December live cattle contract settled down the $1.50 limit on Dec. 9 and 10, so the limit was increased to $3. However, on Dec. 11, the December futures contract settled down $0.45 and the February contract settled up $0.35 so on Dec. 12 the limit reverted back to $1.50.

Futures market exchanges set daily trading limits on futures contracts to prevent wide daily variations in the market, which could be caused by disasters such as the Sept. 11, 2001, terrorist acts. Increasing the limit was necessary because cash fed cattle prices increased $20/cwt. from the beginning of October to the middle of the month. A short supply of market ready, choice grade cattle that met the specifications for delivery on the futures contract and a strong demand for beef caused the run-up in prices.

The $1.50 limit prevented the futures market from keeping up with the sharply increasing cash market. For futures market hedging to work appropriately, the cash and futures markets need to come together at futures market delivery points at contract maturity. By contract expiration on Oct. 31, both the cash market at delivery points and futures market were trading at $101/cwt.

In November, the CME also increased daily trading limits for the feeder cattle contract. Similar rules apply for the contracts that are available in January, March, April, May, August, September, October and November. The daily $1.50 limit is in effect unless either of the two nearby contracts settles at the limit for two consecutive trading days.

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Source: Tim Petry, (701) 231-7469, tpetry@ndsuext.nodak.edu
Editor: Rich Mattern, (701) 231-6136, richard.mattern@ndsu.nodak.edu