The More Things Stay the Same

By Cassie Fish,

Yesterday’s rally in Oct LC, up over 200 points, obviously caught the eye of the remaining few still short that contract. Oct closed at $113.70 yesterday, compared to last week’s average live price of $109.50, but over $5 behind most active Dec LC. So yesterday afternoon, someone tendered 14 loads for delivery in West Point.

This week’s cash trade has yet to get underway, but there have been $110.50 cash trades reported and expectations are that cash will trade higher this week.

Those that follow the intricacies of the CME live cattle delivery process are familiar with the reclaim provision that allows the tendering short the opportunity to ‘reclaim’ his delivery and pick up $1 per cwt if no long demands the deliveries first. Of course, it’s also possible that the initial assigned (oldest) long will accept the delivery, removing the reclaim/demand potential from the equation.

The delivering short can then tender the same cattle again after reclaiming, and attempt to collect another $1 per cwt. Exchange rules only allow a certificate to be tendered twice.

Today’s limitations for physical delivery combined with dramatically more managed fund participation in live cattle futures have altered the behavior of the various contract months and made dominate a combination of roll over and come down. The spot contract has suffered the most and there is not only less incentive for longs to participate in spot, it’s difficult to maintain a sizeable enough position to remain involved or stand for delivery.

When the reclaim provision was installed in the 1980s, the cattle business was dramatically different than today. Stockyards were still functioning and formula cattle were a foreign concept.

There are many that argue the CME live cattle contract is biased for shorts hedgers. Even though the contract has a provision for carcass delivery, given that packing plants are already fully scheduled in advance, it is not actually possible to take cattle carcass delivery, just in theory. So that leaves live delivery as the only ‘real world’ possibility. Taking cattle live has its own set of challenges.

Truth is, the CME live cattle delivery process is antiquated and does not reflect the negotiated cash trade. It is a game of calculated risks motivated as much by an individual’s personal situation and opinion than by price discovery.

The cattle industry has been reluctant to consider cash settlement, and has clung to the old method. But fewer delivery points and fewer delivery days have resulted in more and more tweaks just to provide enough actual days to deliver to correspond with even tiny open interest. And all the while, the contract allows a short to deliver, cross his fingers, and hope to pick up a buck while never moving the cattle.

While in the real world, packers will slaughter 500,000 to 510,000 head of fat cattle this week, all assigned a fair value. That is commerce.

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