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The Definitive Guide to Cattle Futures

- Aaron Levitt

Beef. It’s what’s for dinner. It can also be what’s in your portfolio. As the emerging world continues to modernize, a protein rich diet is on the minds of the growing global middle class. Demand for beef continues to grow at unheard of levels. Analysts estimate that there are nearly 1.3 billion cows being grown for food across the world. That longer-term demand could make cattle one of the profitable investments for traders and investors alike. As with the vast majority of the natural resources space, agricultural commodity cattle is readily available as a traded futures contract.

Understanding just how the cattle market works isn’t difficult; it takes a bit of legwork from traders and investors to get started. And once they do, the rewards of trading cattle futures can be immense.

The Cattle Futures Market

For investors and newbie traders, cattle are traded via futures contracts. These financial instruments give the owner the obligation to purchase a set amount of a commodity—in this case cows—at a certain time for a certain price. Originally, the idea of futures was designed to allow end-users the ability to buy the commodities they need for their operations. However, today, anybody with a brokerage account can trade the financial instruments and gain access to the commodities market.

In terms of the cattle subsector, there are basically two kinds of cows traded as futures contracts: Feeder and Live. The basic differences in the two kinds come down to age and weight. Cows fall into the “Live” category from calf stage until they reach a weight of around 600 to 800 pounds. This usually takes around six-to-10 months for the calf to grow to the necessary weight. From that point they are then transferred to feeder lots—which can hold up to 50,000 cows at some mega farms—and they fall into the “Feeder” category.

Once there, cattle are fed a diet of corn, soybeans, sugar beet waste and various grains in order to encourage rapid weight gain. Feeder cattle are generally slaughtered when they hit a weight of around 1,250 pounds. That process usually takes three to four months. The entire process from calf to steak can take as little as just two years. There are seven states—Arizona, California, Colorado, Iowa, Kansas, Nebraska, and Texas—that produce the vast majority of the cattle for eating in the United States.

In terms of buying futures and investing in cattle, there are only two exchanges that offer standardized Live and Feeder cattle contracts – the Chicago Mercantile Exchange (CME) and Brazilian Mercantile and Futures Exchange (BM&F). However, for most traders and investors, the Chicago MERC is the only real game in town [see also Top 21 Trading Rules for Beginners: A Visual Guide].

The CME’s Cattle Futures

Futures contracts on the CME are available in the two varieties of cattle as well as in both electronic and open outcry trading. Open outcry is when traders stand in a “pit,” shout, and use hand signals to relay information about buy and sell orders.

For live cattle (ticker LC in the open outcry market, LE in the electronic exchange), the CME’s contract represents 40,000 pounds of 55% Choice / 45% Select Yield Grade 3 live steers – these are the USDA specifications on the type of meat each cow can yield. The futures contract is priced in cents per pound and features contracts for the months of February, April, June, August, October and December. Volume is more robust for the electronic marketplace, with the number of trades significantly outpacing pit trading.

For feeder cattle (ticker FC and GF, for open outcry and electronic trading, respectively), the Chicago MERC’s futures contract is similar to its live cattle contract. Priced in pounds, the futures contract is worth 50,000 pounds of 650-849 pound medium-large #1 and medium-large #1-2. Again, those gradings are set to USDA standards. Contracts are available for the months of January, March, April, May, August, September, October and November. Like the CME’s futures for live cattle, volume on the electronic exchange is quite swift compared to the open outcry pits.

Both cattle types are available to trade Monday through Friday from 9:05 am to 1:00 pm central time. Electronic trading of these contracts can be done for an extra 55 minutes each day. Options, which give owners the right to buy, are available on all of these contracts as well.

What Investors Should Know About Trading Cattle

As with much of the commodities complex, investors can use the previous cattle futures contracts to either hedge their own food consumption or profit from rising global demand. Meat prices have risen quite fast over the last few years, as much of our cattle crop is now going overseas. Buying cattle futures today helps lock–in rising prices when you go to pick out your Fourth of July steaks.
At the same time, cattle ranchers can short futures to lock in a selling price for the herds they produce, while meat producers like Tyson or Hillshire Farms can go long to secure a purchase price for meat they will need later.

Aside from rising global demand, there are several factors that tend to move the cattle markets.

One of the biggest is the price of feed. Investors looking into trading cattle futures must pay attention to the prices for corn, wheat and soybeans, as higher feedstocks will trickle down to meat prices. If the cost of feed is too high, cattle is usually sent to slaughter earlier and at lower weights. This tends to lower prices for cattle futures [see also 25 Bizarre Futures Contracts].

Weather can also be a huge market mover for the cattle market. High temperatures not only kill feed, but can also make it difficult for cattle to put on weight. Again, the less weight a cow has, the less its worth. Extreme cases of poor weather can wipe out entire herds, causing longer-term futures to spike, while crashing short dated ones. Bovine spongiform encephalopathy—i.e. mad cow disease—can also spring out of nowhere and drastically reduce herd counts.

Aside from these environmental factors, the thing that moves the cattle market the most is the USDA’s monthly Cattle on Feed Report. The report tells the amount of cattle placed in feedlots that will eventually be sent to market as well as the number of cattle shipped out to the slaughterhouses. You can see how powerful the Feed Report is. The below chart is the current June 2014 contract for Live cattle and it dropped on May 20th – 21st, when the latest USDA report was announced. Showing more cattle on hand than expected.

The Bottom Line

When it comes to beef, playing the cattle futures marketplace can yield some pretty juicy gains for traders and investors. The key is to focus on the various factors that can influence the prices of cattle. From feed prices to the weather export, these factors have more of an effect on both live and feeder cattle pricing than actual demand.

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Quotes of the Day:

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