| MMM 343 | November 9, 1996 |
A significant market change is taking place in the pork industry with the hog futures contracts. For several years, the industry and public have become accustomed to a live hog futures contract on the Chicago Mercantile Exchange, or CME, of 40,000 pounds, prices reported on live-weight basis for 230-260 pound live-weight hogs, and based on USDA quality ranges of USDA #1's, #2's and #3's. Basically, the same contract has been offered on the MidAmerican Commodity Exchange (a subsidiary of the Chicago Board of Trade), or called MidAm, with the contract weight being one-half or 20,000 pounds.
The CME contract will change as of February, 1997 but has already started impacting those producers who hedge and everyone who follows the market. From a data standpoint, this new contract has not been as visible in the reports. CME Commodity futures quotes now contain a mixing of contracts with an automatic shift from the old live hog to the new lean hog between the DEC '96 to the FEB '97 contracts.
With this change, the contract is moving from a live to a carcass weight. The new CME lean hog contract is much like the old live hog one in that it trades in hogs, is still 40,000 pounds, and is traded for the same months. However, there are also differences: the lean hog 40,000 pounds is for carcasses instead of live-weight; the trading unit calls for 170-191 pound base carcass weight range, 51-52% lean, .80-.99 inches of last rib backfat (or equivalent); and, the price is cash-settled to an index.
For the most part, these CME changes are in keeping with industry trends and should be beneficial for producers who sell on a carcass basis and hedge, forward price through options, or use these prices in other ways. There will be (has been) a learning period for the industry, including questions, and some slight adjustments.
For the MidAm, their contract will continue on a live basis but it will also include revisions. The actual contract is moving to 25,000 pounds (220-260 lb. hogs, USDA #1's, 2's, and 3's) and the physical delivery method will be cash settled. This is a major change in philosophy for MidAm hog futures. In the past, MidAm was basically a mini-contract to the CME and producers could usually count on hedging on the MidAm with half a contract for the CME. This now means that producers who continue to sell on a live-weight basis would likely have more advantages in using the MidAm contract. These producers should have more reliability in their hedging basis and be more efficient in tracking prices.
In table 1, some comparisons are made between these contracts. Approximate head per contract have been calculated to help indicate differences between the new and old contracts. Although options are not discussed here, it is important to note that the CME lean hog options are now traded all 12 months with the three off-months called "serial" months. This will improve the availability of options as a forward pricing tool.
Another often asked question about the new contracts is the determination of price. The lean hog price is the CME Lean Hog Index(TM) which is based upon the following data: "a sample of transactions for packer-base weight and base cost hogs. The sample consists of hogs purchased on a lean value cost basis by ooperating packers located within the Mid-South, Eastern Corn Belt and Western Corn Belt areas, as reported by the Federal-State Market News Service on the USDA wire."# In essence, this price (index) is a weighted, multi-day, multi-area average price per pound for USDA reported packer carcass prices.
The MidAm price is based on the USDA Midwest Direct Hog Report with the
final settlement price being the two-day average of the mid-point range for
plant delivered hogs in the Iowa-Southern Minnesota region.@ This price is
common to this area.
Table 1. Comparison of Current Live Hog Futures Contract and Lean Hog
Futures Contract; Selected Specifications/Calculations
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A. CME/MidAM Live Hog Contract (Current until Feb '97 Contract)
Size of Contract: 40,000/20,000 lbs. live-weight
Weight Range: 230 to 260 pounds
Approx. Head/Contract: CME: 173 to 153 (avg. 163) approx. head
MidAm: 87 to 76 (avg. 81) approx. head
Months: Feb, Apr, Jun, Jul, Aug, Oct, Dec
Ticker Symbol: CME: 54 LH MidAm: XH
Minimum Price Fluctuation: 2 ½ cents per 100 lb.
Limit: 1 ½ cents per lb.
Options Months: Feb, Apr, Jun, Jul, Aug, Oct, Dec
B. CME Lean Hogs (Trading Starts with Feb '97 Contract)
Size of Contract: 40,000 lbs. carcasses
Weight Range: 170 - 191 pounds base carcass weight"*"
Approx. Head/Contract: 235 to 209 (average 221) approx. head
Months: Feb, Apr, Jun, Jul, Aug, Oct, Dec
Ticker Symbol: LN / LH
Minimum Price Fluctuation: 2 ½ cents per 100 lb.
Limit: 1 ½ cents per lb.
Options Months: Feb, Apr, Jun, Jul, Aug, Oct, Dec
and serial months Jan, Mar, Nov
C. MidAm Live Hogs (Trading Starts with Feb '97 Contract)
Size of Contract: 25,000 lbs. live-weight
Weight Range: 220 - 260 pounds
Approx. Head/Contract: 113 to 96 (average 102) approx. head
Months: Feb, Apr, Jun, Jul, Aug, Oct, Dec
Ticker Symbol: XH
Minimum Price Fluctuation: 2 ½ cents per 100 lb.
Limit: 1 ½ cents per lb.
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* This weight range is also dependent upon lean and backfat data.
Source: parts taken from CME information and MidAM information.
# from "CME Electronic Rulebook," Chapter 16, Lean Hogs.
@ from MidAm news release, October 1996.
Those not familiar with carcass-based pricing have asked questions about relating carcass prices to equivalent live prices. Those producers who have been selling on a carcass basis do not have trouble with this concept. Using average weights of 180.5 for lean hogs and 245 pounds for live hogs, one can convert from the higher lean hog price to live-weight price by dividing 180.5 by 245 which equals approx. 0.74 (0.73673). This means the lean price is multiplied by a factor of 0.74 to estimate the live price (this will vary for each situation according to the hogs). In other words, a quote of lean hogs for $75.00 would be equivalent to $55.50 live-weight (75.00 * .74 = 55.50). The reciprocal of this would be about 1.35 ( 1 divided by 0.74 or 1.351351) and if the live-weight price were multiplied by 1.35, the lean hog price would be $74.925. Again, these are approximates or rules-of-thumb and should be used as such. The CME and MidAm quotes may also be used as a proxy, although these price calculations are based on slightly different data.
Producers should become familiar with these changes in the CME lean hog
contract and MidAm live hog contract. There are other important items in the
contracts/trading that should be obtained from the commodity exchange, broker,
etc. and studied in detail. These changes should result in improved forward
pricing tools as the industry now has two primary futures contracts, one based
on live-weights and the other on carcass-weights.
