Hedging Against Rising Lean Hogs Prices using Lean Hogs Futures

Businesses that need to buy significant quantities of lean hogs can hedge against rising lean hogs price by taking up a position in the lean hogs futures market.

These companies can employ what is known as a long hedge to secure a purchase price for a supply of lean hogs that they will require sometime in the future.

To implement the long hedge, enough lean hogs futures are to be purchased to cover the quantity of lean hogs required by the business operator.

Lean Hogs Futures Long Hedge Example

A meat distributor will need to procure 4.00 million pounds of lean hogs in 3 months' time. The prevailing spot price for lean hogs is USD 0.6015/lb while the price of lean hogs futures for delivery in 3 months' time is USD 0.6000/lb. To hedge against a rise in lean hogs price, the meat distributor decided to lock in a future purchase price of USD 0.6000/lb by taking a long position in an appropriate number of CME Lean Hogs futures contracts. With each CME Lean Hogs futures contract covering 40000 pounds of lean hogs, the meat distributor will be required to go long 100 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that the meat distributor will be able to purchase the 4.00 million pounds of lean hogs at USD 0.6000/lb for a total amount of USD 2,400,000. Let's see how this is achieved by looking at scenarios in which the price of lean hogs makes a significant move either upwards or downwards by delivery date.

Scenario #1: Lean Hogs Spot Price Rose by 10% to USD 0.6617/lb on Delivery Date

With the increase in lean hogs price to USD 0.6617/lb, the meat distributor will now have to pay USD 2,646,600 for the 4.00 million pounds of lean hogs. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the lean hogs futures price will have converged with the lean hogs spot price and will be equal to USD 0.6617/lb. As the long futures position was entered at a lower price of USD 0.6000/lb, it will have gained USD 0.6617 - USD 0.6000 = USD 0.0617 per pound. With 100 contracts covering a total of 4.00 million pounds of lean hogs, the total gain from the long futures position is USD 246,600.

In the end, the higher purchase price is offset by the gain in the lean hogs futures market, resulting in a net payment amount of USD 2,646,600 - USD 246,600 = USD 2,400,000. This amount is equivalent to the amount payable when buying the 4.00 million pounds of lean hogs at USD 0.6000/lb.

Scenario #2: Lean Hogs Spot Price Fell by 10% to USD 0.5414/lb on Delivery Date

With the spot price having fallen to USD 0.5414/lb, the meat distributor will only need to pay USD 2,165,400 for the lean hogs. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the lean hogs futures price will have converged with the lean hogs spot price and will be equal to USD 0.5414/lb. As the long futures position was entered at USD 0.6000/lb, it will have lost USD 0.6000 - USD 0.5414 = USD 0.0587 per pound. With 100 contracts covering a total of 4.00 million pounds, the total loss from the long futures position is USD 234,600

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the lean hogs futures market and the net amount payable will be USD 2,165,400 + USD 234,600 = USD 2,400,000. Once again, this amount is equivalent to buying 4.00 million pounds of lean hogs at USD 0.6000/lb.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the lean hogs buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising lean hogs prices while still be able to benefit from a fall in lean hogs price is to buy lean hogs call options.

Learn More About Lean Hogs Futures & Options Trading

Ready to Start Trading Futures?

Trade futures now at OptionsHouse.com with special low introductory contract rates!

To buy or sell futures, you need a broker that can handle futures trades.

OptionsHouse is a full fledged Futures Commission Merchant that provides a streamlined access to the futures markets at extremely reasonable contract rates.

Click here to open a futures trading account at OptionsHouse.com now!

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

From Around The Web



Follow Us on Facebook to Get Daily Strategies & Tips!



You May Also Like



Lean Hogs Options & Futures

Futures Basics

Livestock Futures

Options Strategy Finder

Outlook on Underlying:


Profit Potential:


Loss Potential:


Credit/Debit:


No. Legs:





Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2016. TheOptionsGuide.com - All Rights Reserved.