Feeder Cattle Basis: Can There Be Music Among All the Noise?
Feeder cattle risk management poses two clear questions: Is the feeder contract valid, and how can the associated volatility be managed?
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A younger and less attractive sibling
Historically, feeder cattle futures have always been viewed as the younger and less attractive sibling to the live cattle contract. And these sentiments have only grown stronger in recent years. The reason for this is that the feeder contract has always had issues with smaller trading volumes and open interest, making it less attractive to commercial interest, for both hedgers and speculators. Additionally, the imbalance of open interest between the live cattle contract and the feeder contract creates volatility and basis uncertainties in the feeder contract.
Increased volatility and wide basis swings
Many of these problems became visible when the unprecedented rally of 2014 enticed many feeder cattle hedgers to sell into the market too early, causing them to leave opportunity from the top side of the rally on the table. This was followed by the substantially deeper break in the market during the second half of 2015 and 2016, when price declines started earlier and declined much deeper than was expected. This transitioning market has caused increased volatility, resulting in wide basis swings that have led to frustration among all market segments. As a result, it has become necessary to evaluate whether or not the contract is still viable—and to determine how market participants can better understand it.
Two clear questions
With regard to feeder cattle risk management, there are two clear questions: first, whether or not the feeder contract is valid, and second, how the associated volatility can be managed. To effectively evaluate these concerns and provide insight, objective tool(s) are needed with which market participants can sufficiently analyze how to manage the risk associated with feeder cattle contracts.
Where to go from here
RaboResearch Food & AgribusinessPO Box 17100 (UC 053) 3500 HG Utrecht, The Netherlands