Ok Brokenmouth, here's your trade example...:
Let's take your #1 as the better example because #2 is a little light to do this with, but the principle still applies.
Here's the realtime playing field... importance not necessarily in this order.
1.Live Cattle and Feeder Cattle are at/near contract highs, even with lasts years 03 contracts having been about 3 cents higher than this years 04's. This suggests that last year traders looked ahead to more good times; this years is doubtful being down 3 cents and longer months discounted as much as 11cents from front month.
2 Post harvest feed grain prices are down hard and probably going lower as farmer selling hits with new tax year.
3. US Dollar is at multi-year lows - if we can't export at this dollar level, either the dollar has to come down more and/or cattle prices have to come down to find the price level in competition with Australia and South America... don't forget their climate is exactly opposite of ours.
4. Canadian border opening to Live Cattle imports... not if, just when.
5. Low-carb diet fad is leveling out/down...
6. Feedlots are burdened with overweight and oversupply of finished cattle.
7. Packers have been operating in the red supplying retailers with holiday inventory, retail demand may be leveling off.
Given your numbers and averaging weight and numbers gives you 65 steers at 375#... that's 24,375lbs currently and we'll assume you want to grow 'em out to 750#... that's 48,750# which is just shy of the 50,000# Feeder Cattle contract size.
So far we've identified the:
a) 'playing field' we're forced to play on (listed above)
b) your ever-increasing risk (24,375-48,750#)... I don't know your expected ADG but 2.0 takes you out 188 days till sale date at 750#. This places your sale date in between the May 27th (155 days) and August 25th (245 days) options expiration dates. Personally I'd start closer with a March contract at 99 days because the market is more liquid and more manageable, and adjust it as necessary as the market changes.
Your goal as PRICE PROTECTING your investment in 65 head of cattle...NOT SPECULATING! Your 'investment' is what they're worth to someone else right now, not what you paid for 'em...and continues upwardly as you 'grow 'em out'.
I'm not a broker and other than my trading account with a leading commodities broker I have no connection with any of the commodities markets. As such I can't legally make a trade recommendation but if they were my cattle based I'd MANAGE MY PRICE RISK this way.
Long 1 March Feeder Cattle 102 Put @ 3.775 cents for $1,887.50
Short 2 March Feeder Cattle 97 Puts @ 1.950 cents for $1,950.00 (2x$975.00)
Net cash to your account $62.50 ($1,950 less $1,887.50) less commission and fees.
What I've done at this point is give myself the opportunity to sell 50,000# of cattle at 102 and at the same time buy 'em back at 97... This establishes for a 5 cent trading range and helps protect my trading position. If the market goes up, the 102 Put loses money but is offset by the two short 97's making money at an equal or greater rate... and if the market goes down the102 Put gains money while the 97 Puts also gain money, but because I'm short, it offsets the gain on the 102 Put.
THE OBJECT HERE IS TO PROTECT THE OPTIONS POSITION THAT'S PROTECTING OUR FEEDER CATTLE POSITION.
Notice that I bought a Put... it's an asset to me and obligates me to nothing beyond the $1,887.50 premium paid to the seller. Additionally I'm short two Puts, one which offsets the long 102 Put and a second Put called a 'naked leg'. This could become a potential liability to me.... but three things are important about this 'naked' leg.
1) It's already about 4 cents under the 101.53 futures price and well out of range of me being 'put to' by the buyer.
2) The buyers breakeven is 97 minus 1.950 cents or about 95 cents so futures would have to get down to 95 or better for him to exercise... meantime I would have moved it even lower..
3) Time decay is working on both the short Puts over the 99 days... by managing these correctly I anticipate keeping the $1,950.00 premium paid to me.
Possibilities:
As the March contract moves towards expiration it becomes more influenced by the cash market. If during the 99 days the March Feeder Cattle futures declined about 4 cents to say 97 and all things being equal, we'd pick up about 4 cents (102-98) or $2,000.00 (.04x50,000) on the price differential. Additionally if I held the two shorts to expiration (and continued to manage them) I'd be able to keep the $1,950.00 premium paid to me... less time held less premium. Note: If futures approached 97 on the downside, I'd move the two shorts further down to retain their premium value to me and prevent being 'put to'. Whereas I may have correctly predicted that the market traded to the downside, there's such a thing as being 'too right'... and I need to protect you short Put positions by moving them out of the way of my being 'put to'.
If March futures moved upwards against me, my long Put would decline in value for two reasons; first it too is decaying in premium value, and secondly being above the 102 strike price, it's only value is speculative and subject to what's call 'implied volatility'... in other words only what the market will bear... and the closer to expiration it will become zero. But I've protected my 'hinnie' by establishing the two 97 short Puts... and as the market moves upward the value of the short Puts declines to zero... and I make a profit on them to offset the loss on the long 102 Put.
If March futures stay in my trade range of 102-97 I'll make money on the downward price move AND I get to keep the $1,950.00 premium paid to me on the short 97's.
My main focus here isn't to make money on the options position but to protect my cattle position; and only secondly to make additional money on the options position itself.... NOTICE HOW I'VE NOT ONLY PROTECTED MY CATTLE PRICE POSITION TO THE DOWNSIDE.... BUT ALSO PROTECTED MY TRADING POSITION.
Far too often 'new money' is shortsighted by attempting to establish a position and failing to either protect or manage that position... Then when the market moves against them they lose money.
There ye go.... Richard
