A SIMPLE COMPARISON OF THE CASH AND FUTURES MARKETS
FINISHED BEEF CATTLE BETWEEN 1968 AND 1977
P.J. van Blokland
Florida Cooperative Extension Service
Institute of Food and Agricultural Sciences
University of Florida, Gainesville
John T. Woeste, Dean for Extension
The Institute of Food and Agricultural Sciences is an Equal Employment Opportunity-Affirmative Action Employer authorized to provide
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A SIMPLE COMPARISON OF THE CASH AND FUTURES
MARKETS FOR FINISHED BEEF CATTLE BETWEEN
1968 AND 1977
P. J. van Blokland
The essential purpose of this paper is to compare the results of
short hedging each contract in the live cattle futures market with selling
in the cash market over the ten-year period between 1968 and 1977. The
paper underlines the neglected point that the futures market transaction
involves three prices, rather than two and quantifies the different re-
sults from using the usual two price concept with the realistic three price
situation, as well as quantifying the cash and futures market performance
over this time period. These quantifications are presented in terms of
feedlot services margins.
The paper shows why the futures market cannot always provide satis-
factory returns for hedgers and suggests that even a superficial knowledge
of price trends and inventory will demonstrate when a hedge can prove suc-
cessful. The major emphasis involves the futures contract close out price.
While the paper does not deal with hedging strategies per se, it intimates
that their relative success basically depends upon this closing out or buy
Key words: futures market, hedging, live beef cattle, feedlot services
margin, price, cash market, buy back, farmer.
TABLE OF CONTENTS
LIST OF TABLES ....
LIST OF FIGURES . .
METHOD OF PROCEDURE..
THE RESULTS . . .
CONCLUDING REMARKS .
REFERENCES . ...
. . . . . .
. . . . . . . . . .
. .o o .lo e o o o o e o o o
. . .
LIST OF TABLES
The difference between the true futures feed-
lot services margin and the cash feedlot ser-
vices margin, for every 100 lbs. of liveweight
gain, in bi-monthly intervals, 1968-1977......
LIST OF FIGURES
1 Feedlot Services Margin per cwt. Liveweight
Gain . . . . * ............
2 Choice Omaha Steer Prices ($/cwt. liveweight)
3 Number of Cattle on Feed in 23 States (1,000
head). . . . . ... . * * *
A SIMPLE COMPARISON OF THE CASH AND FUTURES MARKETS
FOR FINISHED BEEF CATTLE BETWEEN 1968 AND 1977
P. J. van Blokland
Futures market prices are interpreted differently by different people.
However, it is generally held that the futures price for storable commodi-
ties broadly reflects a cash price and a carrying charge for storing, in-
terest and transportation, usually determined by market circumstances [6,
pg. 1254-1262]. This interpretation is, perhaps, not so easy to apply to
the non-storable commodities. Their futures prices are ordinarily considered
to be a current forecast of the eventual cash prices [4, pg. 372-380]. Yet
the implication of both these opinions is that the futures market does pro-
vide a forward pricing mechanism for both storable and non-storable commod-
ities [3, pg. 271-279]. But despite this apparent advantage, it is evident
that farmers are often less than enthusiastic in using the futures market,
particularly those farmers producing non-storable commodities. Many of
these farmers have tried this market and then returned to their traditional
marketing methods without realizing quite what went wrong.
This paper, therefore, has two main goals. One is to show why the
futures market has not always provided satisfactory results for feedlot
operators attempting to hedge their cattle. The second is to indicate that
there are times when this market should not be used. The method of analysis
to meet these two goals is to compare the financial results from hedging
every contract for live beef cattle for the ten-year period between 1968
Dr. van Blokland is an Assistant Professor in the Department of Food
and Resource Economics.,
and 1977 (i.e. 60 contracts) with the results of selling in the cash market
over the same period, and to combine these figures with time series data
on the number of cattle on feed. This approach helps in identifying the
right and wrong times to use the futures market, and also quantifies the
results of continuously hedging, regardless of market circumstances.
Futures market trading is usually presented as involving two markets
and hence two prices. The two market concept is correct. Beef producers
use the futures market to forward price by trading paper, and maintain
their normal livestock cash markets to trade cattle. But the concept of
two prices is incorrect. There are three prices that the farmer has to
consider. Once he decides to produce fat cattle, he is then concerned with
the price for his finished product in the cash market. This is the one
and only price in this market. But in the futures market there are two.
One is the price at which he sells his contract, usually at the time he
purchases his feeders. The other is the price at which he buys back his
contract, generally just prior to selling his finished cattle.
It is this latter price, the buy-back transaction, which has probably
resulted in the disappointing performance by many individuals. And it
is not entirely their fault. Much of futures market literature illustrates
the myth of the perfect hedge. Thus market proponents neglect to inform
potential practitioners that, because this third price exists, it is simply
not possible to lock in a profit, or even a final price. Hence a trader
new to the futures market is often surprised to discover that he has to re-
purchase his contract some time later at considerably more than he sold it
Method of Procedure
This investigation relies on the following assumptions:
(1) that the feedlot operator purchases and finishes six groups of
feeders a year,
(2) that 600 lb. Choice feeder steers are purchased at Kansas City
prices and sold as 1000 lb. Choice fed steers in the cash market
at Omaha prices; or that the price differential of Kansas City
550-750 lb. purchased feeders and Omaha 900-1100 lb. sold fat
cattle is a reasonable representation for any feedlot planning
(otherwise it would pay to arbitrage),
(3) that the feedlot operator will use either the cash market only,
or the futures market only between 1968 and 1977, and
(4) that the cattle contracts) are sold when feeders are purchased
and the contracts bought back five months after the initial pur-
chase of feeders in the month prior to contract maturity (it is
usually a wise rule for hedgers to stay out of the delivery month
when trading because this is a volatile time when the large specu-
lators attempt to profit by matching longs and shorts).
These assumptions provide the background for the investigation. The
ensuing procedure relies on historical data in comparing the cash and fu-
tures market transactions from the start of 1968 to the end of 1977, using
the months of the live cattle futures contracts, namely February, April,
June, August, October, and December. Consequently, there is a total of
The futures price for selling is the closing price on the twelfth day
of the month the feeders were purchased for the futures contract maturing
six months hence. The futures price for terminating the contract is the
closing price for that contract on the twelfth day of the month prior to
the delivery month.
The two markets are compared using the concept of "feedlot services
margin" or FSM. The FSM is the difference between the value of the fin-
ished cattle and the purchased cost of the feeders. For example, if 600
lb. feeders were purchased at $50 per cwt. and later sold as 1000 lb. fed
cattle for $45 per cwt., the FSM is I (45 x 1000/100) (50 x 600/100)], or
$150, or $37.50 per cwt. of liveweight gain. This feedlot service margin or
FSM is only known when the cash market transaction is completed. So the
producer who uses the cash market alone will have little idea of his returns
until the cattle are sold. In contrast, the futures market does provide some
idea of the final margin before the cattle are sold, through its forward pricing
mechanism. The margin for those producers using both the cash and the
futures market is the "futures feedlot services margin", or FFSM, while the
margin for producers who use the cash market only is the "feedlot services
margin", or FSM.
The futures market does reduce the risk of marketing at an unknown
price, but it still involves risk because the price of buying back a con-
tract is unknown. Hence, the FFSM is treated in two ways. The first
method simply uses the contract selling price and the cost of the purchased
feeders. These figures are known before the fattening period starts, and
are perhaps the main cause of user dissatisfaction with the futures market,
particularly when the user is told (incorrectly) that he is locked in to
a price. The second method, therefore, does include the difference be -
tween the selling price of the contract and its buy-back price. This
second procedure provides the true results from using the futures market
and the margin is, of course, unknown when the feeders are bought (only if
the basis stays the same will the first and second futures market methods
provide the same result).
For example, assume that 600 lb. feeders were bought for $40 per cwt.,
and at the same time a live beef contract was sold at $47 per cwt. which
was later bought back at $49 per cwt. Then the first method would show a
FSM of $170 and the second $150.3
There are, then, three feedlot services margins which will be examined.
(1) the cash market FSM
(2) the misleading FFSM (method one in the futures market)
(3) the true FFSM (method two inthe futures market)
Figure 1 summarizes the basic data in terms of dollars per cwt. live-
weight gain. It shows that a feedlot operator using the cash market only
between 1968 and 19g7.got better results than if he always used the futures
market. In fact, the futures market (i.e., the true FFSM) out-performed
the cash market only twenty-four times in this ten-year period. Thus the
cash FSM line is nearly always higher than the two FFSM lines. It also in-
dicates that the true FFSM was usually less than the misleading FFSM (the
'"misleading" FFSM is referred to as the "chosen" FFSM in the figures). Thus,
the operator is led to believe that the futures market is better than it
Table 1 compares the cash FSM and the true FFSM over this time period
in dollars per 100 lbs. of liveweight gain. It shows what an operator
would have gained or lost for every cwt. of liveweight gain by using the
futures market rather than the cash market. If the number is positive, then
*~ I I
E~~c~to 0 00
Table l.--The difference between the true futures feedlot services margin and the cash
feedlot services margin if dollars per cwt. of liveweight gain, in bi-monthly
February -4.13 -7.
April -2.70 3.
June -5.83 6.
August -6.80 -5.
October -15.40 -6.
December -22.55 1.
Total over the year
e FFSM minus
cash FSM per cwt. liveweight gain
1971 1972 1973 1974
-5.27 -9.74 -32.27 25.84 -3
-5.81 -7.22 -2.45 28.87 -3
-13.30 -1.95 24.83 -5.77 -1
-17.02 -29.58 45.27 31.93
-10.89 -31.47 28.45 10.60 -
-19.83 -22.22 36.40 -24.63
-57.41 -8.64 -9.47 -72.10 -102.18 100.23 66.84 -69.25
.104.31 -64.45 -112.12
the futures provides a better price than the cash market. Conversely,
if the figure is negative then the cash market is better.
This table shows that the futures market provided better results
than the cash market in only three out of ten years given the four assump-
tions listed previously. It also records that a continuous hedging strate-
gy over this time would have lost the operator $112.12 for every cwt. of
liveweight gain, compared with the simpler cash market only transaction.
No single contract month is apparently much better than another in
the comparison. However, the April contract did provide somewhat higher
prices than the cash only strategy in five years out of ten, while the De-
cember contract only managed this for three years. The other contracts
all recorded higher futures gains in four years. The total results
of each contract over this ten-year period may initially appear signifi-
cant, in that the April, June, and August contracts have out-performed
the cash market. But some reflection should suggest that this interpre-
tation is not particularly satisfactory. For example, the operator would
have to wait eight years before gaining in the April contract, which is
the best of the threecontracts.
These conclusions have, so far, been rather simplistic. One of the
basic objectives is to find the times when the futures market should be
used and when it should not. Simply recommending the April contract is
probably not a good conclusion. How, then, can a feedlot operator know
what to do?
The basic answer involves looking at cattle prices and the number of
cattle on feed. Figure 2 presents the pattern of Choice steer prices in
Omaha from the beginning of 1968 up through mid-1978, in dollars per 100
1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978
Figure 2 -- Choice Omaha Steer Prices ($/cwt. liveweight)
lbs. of liveweight. Without attempting a technical examination, it is
still possible to discern six main movements in this pattern [5, pg. 1].
(1) From early 1968 to the end of 1970, prices remained fairly steady,
albeit showing a slight rise, with a 10% variation around the
mean price of $30. This stable period lasted two-and-one-half
(2) Then, from the beginning of 1971 up to the end of the summer of
1973, prices rose continuously and much more sharply, from a low
of $27 to a $63 peak. This two-and-three-quarter years' trend
therefore doubled prices.
(3) After August 1973, prices generally fell for around 18 months,
dropping to $35 with two brief corrections in early and late
1974. By the spring of 1975, prices had fallen by one-third.
(4) Then came a nearly six-month correction which increased prices
into the low $50s.
(5) Prices then resumed their falling pattern, bottoming out in the
high.$30s, with an average price during this period of around $40.
(6) Finally, in the summer of 1977, prices started to climb and by
June 1978 had grown by 50%.
What caused these movements? The obvious answer is that prices gener-
ally fall when there is a large supply of cattle, and they rise when cattle
numbers fall. Figure 3 illustrates this answer in presenting the number
of cattle on feed in the 23 major feeding states. The number of cattle on
feed rose from around 10.5 million head at the start of 1967 to about 14
million by the end of 1972. This inventory build-up could only be sold at
when futures market is
better than cash market
Figure 3 -- Number of Cattle on Feed in 23 States (1,000 head)
lower prices. Hence farmers began to reduce the numbers on feed after
this date, and they fell to nearly 9 million at the turn of 1975.
Prices follow the same broad pattern. Farmers will generally in-
crease the number of cattle on feed if prices are rising. The numbers
followed prices up to the August 1973 peak. Then came the staggered price
fall, triggered by a successful consumer boycott of high beef prices and a
synonymous consumer switch to cheaper meats (annual per capital beef consump-
tion fell in 1973 for the first time since World War II). This situation
was exacerbated by a historically high number of cattle on feed. These
could only be sold at lower prices, so numbers followed cattle prices down,
bottoming out in late 1974 and early 1975.
Then, after brief upward correction, prices resumed their downward
trend so that in January 1977 the number of cattle on feed was about the
same as in January 1969. Yet beef consumption had increased 14 lbs. per
head during that period, and population had expanded by approximately 12
million and real income by 7%. So prices had inevitably to rise. That
they have considerably further to go is suggested by the January 1978
cattle numbers which are similar to those in 1970.
The futures market generally performs better than the cash market
when prices are falling, due to the sell and later buy-back transaction.
In other words, the later buy-back price is less than the earlier sell
price, producing a gain on the futures transaction. There are, therefore,
two main periods in this historical sequence when the futures market out-
performed the cash market. These were mid-1973 to late 1974, and mid-1975
to early 1977 (both with the exception of one month), and they correspond
to the two main times of falling prices in the fat cattle market.
Most cattle farmers are, of course, aware of national price trends.
But the basically simple fact that the futures market will provide greater
rewards than the cash market alone in times offalling prices has apparently
been overlooked. As price movements do tend to move in one direction or the
other for a reasonable length of time (admittedly with problematic correc-
tions), it should not be too difficult to take advantage of these movements
in deciding whether to place a hedge or not. In this historical time
series there have been two major periods of price falls. One lasted for
about two years and the other lasted nearly a year and will apparently
run on for some time [2, pg. 23-25]. Table 1 suggests the advantages that
might have accrued from selecting between the cash and futures market al-
The evidence from 1968 to 1977 shows that a farmer who used the cash
market only would have done better than a farmer who used the futures
market only. There were just two periods during this time series when
the futures market transaction was preferable to traditional cash marketing.
These were approximately from mid-1973 to late 1974 and from mid-1975 to
early 1977. The reason for the better performance is simply that the fu-
tures market transaction itself resulted in a profit because the buy-back
price was lower than the original sell price. The reason for this profit-
ability, in turn, is that these were times of falling cattle prices, due
to an oversupply of cattle.
But how can a farmer exploit times when trends are not so clear? An
answer to this question requires involvement with hedging strategies, and
particularly with timing the buy-back decision. It is not the purpose of
this paper to investigate these strategies, though there is some good re-
search available. The main purpose has been to show what can be accomplished
by using the basic simple tools of cattle prices and cattle numbers.
These are the tools that matter, and provide the essential data for
developing strategies and charting techniques. More importantly, they
provide the basic information for sensible marketing, and most important
of all, it is knowledge that the farmer may already possess. This un-
doubtedly inchoate paper is intended to show just that.
1These price relationships can also be discussed in terms of basis
movements, where basis is the difference between the Chicago futures
price and the local cash price, including some additional adjustments.
However, as many people have some difficulty with the concept of basis,
and as this paper attempts to avoid futures markets techniques and terms,
it was felt that a price presentation would prove clearer (however, any
potential traders must realize that a thorough knowledge of basis is essen-
tial to a successful trading).
2There is nothing significant about using the 12th day of the month.
One day is essentially as good as another.
3Both methods are included to show, in the first method, the price
at which the farmer decides to enter the futures market and, in the second-
method, what was the true result of using this market (transaction costs
4This conclusion ignores the possibility that the farmer may, indeed,
sleep more soundly if he has lowered his market risk by hedging, and there-
fore be compensated for lower returns in the futures market.
 Hieronymus, T. A., "Economics of Futures Trading", Commodity Research
Bureau, Inc., Newy York, 1971.
 Jacobs, V. E., "Cattle Rally: A Mid Year Assessment", Commodities,
June 1978, p. 23-25.
 Leuthold, R. M., "The Price Performance on the Futures Market of a
Non-Storable Commodity: Live Beef Cattle", American Journal
of Agricultural Economics, Vol. 56, No. 2, May 1974, p. 271-279.
 Tomek, W. G. and R. W. Gray, "Temporal Relationships Among Prices on
Commodity Futures Markets: Their Allocative and Stabilizing
Roles", American Journal of Agricultural Economics, Vol. 52,
No. 3, August 1970, p. 372-380.
 Waugh, F. V., "Graphic Analysis: Application in Agricultural Eco-
nomics", Agricultural Handbook 326, Economic Research Service,
Washington, D.C., November 1966, particularly page 1.
 Working, H., "The Theory of the Price of Storage", American Economic
Review, Vol. 39, December 1949, p. 1254-1262.
WA~Y 30 1991 2JgZ 21 4 --
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