CME suggests increase in futures limits contracts |

CME suggests increase in futures limits contracts

The Chicago Mercantile Exchange recently proposed an increase to the number of contracts that an entity can legally hold. In layman’s terms, this means that the speculators who buy futures contracts, can buy more of them.

Futures markets work differently than most markets in that an initial position can be executed on either the buy or sell side. In this way, participants can make money if the market goes down as easily as they can make money if the market goes up. People who think the market will go down will enter a “short” or “sell” position, and profit if the market goes down. People expecting the market to go up enter a “long” or “buy” position, and profit if the price rises. To exit a position and take profits (or losses) traders execute a trade in the opposite position at the current market price. The participant has then bought one contract and sold another, and the two cancel each other out. As with any market, the difference between the “buy” price and “sell” price determines the profit or loss of the transaction.

Cattle feeders often enter short positions in live cattle futures as a hedge, expecting that the money made in the futures if the price goes down will offset the decreased value of their cattle. Long hedgers are people who lose money in their core business if prices go up. A processor is an example of a long hedger.

In addition to hedgers, futures markets depend on speculators who own no cattle and buy no beef, but try to make money on price movements. These participants are important, because each position needs a buyer and seller. If cattle feeders want to hedge, they need someone to enter a buy position, and there are not as many long hedgers as short hedgers, which is where speculators step in to keep the market working.

To keep speculators from cornering the market, the number of long positions any speculator can hold is limited by regulation. The CME is now proposing an increase in the current limit of 450 contracts to 600 contracts that a speculator can own during the month that a particular contract expires.

Brett Crosby, an economist and rancher from Cowley, Wyoming, said that in recent history, supermarket chains, restaurants, or others marketing beef have sometimes been long hedgers to protect themselves against a bump in beef or boxed beef prices. But because the relationship between the price of beef and the price of live cattle has weakened significantly in recent years, these entities can no longer effectively use futures contracts as a risk management tool.

“There is no such thing as a long hedger anymore. The only people who will take the other side of the hedge positions that the feedlots have are speculators. We need to allow speculators to come in and take the other side of a position as people sell live cattle futures to protect themselves against a market drop,” Crosby said.

Often it is big investment firms like Goldman Sachs who buy the long positions, to hedge against inflation, said Crosby. And sometimes the current limit of 450 contracts prevents some cattle feeders from being able to sell a contract when they are ready to do so, because there aren’t enough sellers.

“For every buyer there has to be a seller and for every seller, there has to be a buyer,” said Crosby.

Crosby believes this proposal should help maintain an appropriate value for futures contracts by providing more liquidity to the market.

“Think of your local salebarn. If there are 5,000 head to sell and only three order buyers, by the end of the sale, the calves that are left will take a hit because the order buyers don’t really want them but eventually if the price gets cheap enough, they step in and buy them,” he said.

“But if you have three order buyers and 50 farmer feeders, there is more likely to be someone at the end of the sale still looking for calves. The price won’t change throughout the day as much when there are more participants in the market.”

Crosby said the cattle feeders will benefit from the policy change because of the increased liquidity and that the cow-calf producer should theoretically benefit from the feeder having the opportunity to improve his or her bottom line.


See more

Start a dialogue, stay on topic and be civil.
If you don't follow the rules, your comment may be deleted.

User Legend: iconModerator iconTrusted User