1. What is it?
It’s possible to trade with cattle contracts at BM&F. The object of the contract is an ox with this following specs: male, castrated, well developed, grown in a grassland or confinement, weighing between 450-550 kg and 42 months-old the most.
It is traded in arrobas – or 15 kg. The lot comprises 330 arrobas, or 4,950kg – that’s 1 contract. Physical deliveries are possible, but for such the buyer must meet BM&F rules, by filling a document that seals his intention of physically exercise the commodity (AILE). The cattle must meet all requirements proposed by BM&F. Physical executions also imply into transport, freight and other costs. However, if the investor is not looking for a proper delivery, notes will be financially liquidated by the expiry date (most cases).
That sounds weird in a first moment the fact that BM&F trades cattle contracts, but that makes sense. This market was first created to assure a pricing basis for both producers and meat processors, giving them some protection against the variable income market. Therefore, the future trading of Cattle guarantees the price of cattle at a specified future date. This way producers can make fair revenues from their output, covering costs and making profits, as well as buyers, who get a fair pricing by the end of the day.
As Brazil figures as one of the largest beef exporters, companies like JBS Friboi, Marfrig and Brasil Foods, for instance, compete with other countries on the cattle markets. Thus, it is crucial to assure a good pricing for them to align costs and cash flow. By using cattle futures, they can pavement the road for continuing with their activities.
BM&F alone is not the sole stock exchange dealing with cattle futures. Chicago’s (CME) and Australia’s (ASX) stock exchanges also offer this commodity. And trading for them is not restrained to producers or processors, but also include speculators and general investors looking for making money from cattle pricing changes.
Prices for cattle contracts are measured in BRL per net arroba. Each contract corresponds to 330 net arrobas. To find the pricing for a single contract, one needs to multiply the current price of an arroba for 330. So, if an arroba is valued at BRL100.00, then the contract pricing will be standing at BRL33,000.00.
Cattle futures pricing change according to prices practiced in the physical marjet. Usually, cattle prices are considered calm and relatively steady, with changes relatively predictable, where investors base their decisions on technical issues and spreads – the difference between physical prices and future price trends.
Trends reflect, in addition to the conditions of the animals, weather changes and conditions. For instance, in Brazil, cattle prices tend to be lower in July and September. These months comprise the worst of the local winter, when grasslands are usually smaller. Thus, the cattle in the pasture have less food to eat, since the grass does not grow as much as in other months of the year. If the cattle does not eat much, he tends to lose weight, generating less revenue for cattlemen. So they tend to sell the cattle at a lower price as they are fat this time of year, making the supply of beef will increase, reducing the price of meat to the final consumer.
Reference cash prices for cattle contracts are based on ESALQ (USP/Piracicaba) index, done in conjunction with the BM&F. It’s daily updated, from a research made by the center for advanced studies in applied economics, the college of agriculture Luiz de Queiroz academy, an USP division.
Cattle futures terminology is found from the following factors:
1. Cattle futures trading code is “BGI”.
2. The letter corresponds to the expiry month, as follows:
3. Expiry year.
Example: to deal with a BGI future expiring by September 2014, the code is the following:
BGI U 14
Cattle futures contracts have the following characteristics:
|Trading unit||330 arrobas (1 contract)|
|Quotation||BRL per net arrobas|
|Minimal Quotation Change||BRL 0.01 per net arroba|
|Maximum Quotation Change||3.5% on the price of the previous maturity day’s settlement negotiated|
|Standard Lot||1 Contract|
|Position Limits||1,000 contracts or 25% of the open positions per month of expiration|
|Trading Timetable||9am – 4pm (Regular Trading) / 5pm – 6pm (After Market)|
|Last trading day||Last work day of the expiry month|
|Guaranty Margin||3.34% of the trading volume (updated daily by the stock exchange, following margins criteria for futures)|
It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of BGI futures. The settlement of day trades is performed automatically on the first business day following the date of closing of the business.
The daily settlements is nothing more than a mechanism used by BMF&Bovespa to balance the investor accounts. As futures change in a daily basis, generating credits or debts, investors are daily updated on their positions, earning or losing as prices change – in other words, they either get their profits or pay for their losses daily. The mechanism is a protection against any noncompliance among investors.
For BGI contracts, the daily adjustment happens the day after the deal, or D+1. However, on the expiry date only, updates are made in the same day, or D+0.
It is a value deposited in cash or notes which will covering any noncompliance of an investor in daily adjustments. Usually to operate options, the investor is forced to deposit a guarantee to mitigate risks. The margin is defined by the stock exchange, according to the analysis of the futures market.
The assets accept as guarantee include cash, gold, government or private bonds, letters of pledge and quotes at funds.
For BGI contracts, the guaranty margin is aproximately 3.34% of the total invested amount.
There are two kinds of operational costs for dealing with cattle contracts:
Brokerage – it can change depending on the broker. However, most of them use the basic operational fees, stipulated by Bovespa. In this case, costs reach 0.3% for regular operations and 0.07% for the day trade, based on the theoretical redeem value.
Stock exchange fees – that includes emoluments and registering fees by BM&F, charged as follows:
Emoluments: The fees charged by the BMF values related to trading services. They focus on contract negotiation (opening or closing position before maturity), exercise of options, registration and early settlement and assignment of rights procedure. On BGI futures contracts, the fees are charged according to the following table:
|Number of contracts||Value per contract|
Liquidation charge: this charge regards to the liquidation of the contracts by the expiry, on top of clearing expenses. Usually, this charge is a fixed value, and has nothing to do with the volume of contracts negotiated. For cattle futures, this charge stands at BRL 2.08 per contract.
Clearing fees: include all costs for following positions and receiving reports and filings made by the clearing house, as well as operational costs for holding inactive positions on derivatives. It affects all positions opened in contracts traded in the primary market (except for options and minicontracts) and OTC contracts. The fees are daily updated, and charged in the last work day on each month, by closing the positions or every time an investor transfers all positions to another one.
Fees are based in the number of positions opened by the calculation day, and can vary depending on the volume of contracts traded.
For BGI contracts, fees reach 0.0303% per contract or day.
Registry charge: a value charged to register the operation on the clearing house, that only applies to deals that open or close positions before the expiry date, and charged one day after those events.
The table of prices for registration is disclosed by the stock exchange based on average deals for the latest 21 trading sessions. Calculations are made in the last trading session of a week, and define registration charges for the following week.
Currently, registration charges for BGI futures are estimated as follows:
|Number of Contracts||Registration charge|
Maturity dates for BGI futures can be set up for any month in the year. The expiration date as well as the last trading session happen by the last work day of the expiry month.
By the expiration date, all positions that remain opened, after a last adjustment, wil be financially executed by the stock exchange, by registering the inverse operation of the position held.
In order to trade with BGIs, the investor needs to cash out high values, either for the initial margin or buying the contract itself. The solution found for attracting small companies and individuals was creating a “mini” BGI.
Rules and standards for the mini BGI are equal to those for regular BGIs, but the minimized contract comprise a lot of 33 arrobas, or 10% of the original BGI.
The main advantage for the mini BGI is reducing the cash needs for operating the with the commodity, which leads to lower operational costs, that can be accessible for smaller investors.
The terminology for dealing with mini BGIs stands as follows:
1. Trading code for mini Cattle contract is “WBG”.
2. The letter corresponds to the expiry month, as follows:
3. Expiry year.
Example: for trading with mini Cattle contracts expiring by August 2014, we have the following code:
WBG Q 14
The regular lot for trading with WBGs is 1 contract. Rules for initial margins, daily adjustments, liquidation, expiration and taxes are basically the same as BGI’s.
Trading costs, however, are lower. Brokers usually grant a discount for WBGs, offering reduced costs for day-trade operations. Emoluments and liquidation fees are still applicable, but at a lower rate.
Cattle Roll Over – BR1
Roll over operations on Cattle – BR1 – comprise the strategy of dealing with two different expiration dates of cattle futures at the same time.
Procedures and rules remain the same as regular contracts. However, for BR1 deals, instead of generating new positions in a new contract, it will be automatically transformed in two different operations: the first will have the expiry date set up as being the BGI’s original date (short leg), and the second fixed for expiration in the BR1’s set up date (long leg). Thus, the BR1 will not have open positions at the end of the day, being distributed on their business maturities of Cattle futures contract.
3. Profitability and risks
Risks and profits from investing in cattle futures are realted to price changes of cattle in the physical markets and spot markets. Changes can happen for a serie of factors, like demand and supply ups and downs. If an investor buys a cattle future and prices drop, he loses money. Equally, if he sells a position and prices go up, he lost an opportunity of making money.
Cattle futures are widely used for hedging positions, or protecting companies and farmers against possible changes on prices. However, these contracts are also used for speculating and making money from short selling moves.
Taxes over BGI futures follow the same logic of any other variable income investment. Income tax is equal to 15% of the sum of all daily adjustments (if positive) and is charged just when you close a position. Also, income withholding taxes of 0.005% are due over the full amount of gains.
For day trade operations, the income tax reaches 20% of profits, and the withholding tax other 1%.
All costs and fees paid for investing can be deduced from the income tax amount, including those from BMF&Bovespa. In case of losses, a compensation can be applied in any gains in the subsequential months, as long as the operations are similar.
The payment of taxes is the responsibility of the investor himself, except when the tax is direct at source and must be calculated and paid monthly on the last business day of the month subsequent to the determination. The calculation is performed over the term of the contract and not monthly.
1. Cattle futures
Let’s say a creator wants to sell part of his herd. He intends to sell 3,300 arrobas. He expects prices to go down for BGI. So, he wants to hedge his business against the price drop, and assure the current prices for future deals, making a decision of selling 10 contracts on future markets, at a price of BRL59.80 per arroba. As each contract is equal to 330 arrobas and he wants to sell 3,300 arrobas, so 10 contracts are enough for hedging his position. Consider the following figures:
|Herd’s extension (arrobas)||3.300|
|Size of contract||330|
|Price per arroba||R$ 59,80|
|Contracts to sell||10|
|Date of sale||11/31/2013|
As days go by, then we have the following changes (daily settlements):
|Date||Adjusted price||Daily Settlements|
|D+60 (Maturity)||R$ 58,00||-660,00|
D+0: on the first day, 10 contracts are sold for R$ 59.80 per arroba.
D+1: cattle futures prices drop to R$ 58.80. Thus, the daily change is found from the difference between the current and the previous quotations (R$ 58.80 – R$ 59.80) times the number and size of contracts (10 * 330 = 3,300). So, as prices drops, we have a positive adjustment of R$ 3,300.00.
D+2: prices hike and we have a negative adjustment of R$ 1,650,00. (R$ 59.30 – R$ 59.80) * (10 * 330) = – R$ 1,650.00.
D+3: another drop and a new positive move. (R$ 59.00 – R$ 59.30) * (10 * 330) = R$ 990.00.
D+4: again, prices drop and adjustments are positive. (R$ 58.70 – R$ 59.00) * (10 * 330) = R$ 990.00.
D+5: a third drop, with positive adjustments. (R$ 57.80 – R$ 58.70) * (10 * 330) = R$ 2,970.00.
These adjustments will happen until the maturity date. It is there that we know if the farmer will make a profit or loss on the transaction Cattle Future. If at maturity the price of the Cattle close to R $ 58.00, the result is the following:
1. Cattle is sold for spot prices, or R$ 58.00, making revenues of R$ 191,400.00 (3,300 Arrobas * R$ 58.00).
2. Gains of R$ 5,940.00 from cattle futures, after all daily positives and negatives changes accounted.
3. Farmer’s total income reaches R$ 197,340.00, considering the selling and the profits from operations (R$ 191,400.00 + R$ 5,940.00). It works just like he sold the cattle for R$ 59.80 per arroba rather than the current spot prices of R$ 58.00.
2. Mini cattle futures
Let’s consider a small knacker in Brazilian inlands. He needs to buy 1,500 arrobas by the end of October, expecting hikes for cattle prices. So, as a way to waive the increase, he decides on buying a cattle mini futures, to set up a hedge. To find how many contracts he needs to be buying, simply divide the amount of Arrobas by the size of the contract. That is::
= 1,500 Arrobas / 33 Arrobas per contract = 45.45 (45 contracts)
Consider the following figures:
|Arrobas to be purchased||1.500|
|Price per arroba||R$ 90,00|
|Number of contracts||45|
As days go by, then we have the following changes (daily settlements):
|Date||Daily prices||Daily Settlements|
|D+90 (Maturity)||R$ 93,38||900,00|
D+0: on the first day, 45 contracts are purchased for R$ 90.00 per arroba.
D+1: cattle futures have a price drop to R$ 89.50. Thus, the daily change is found from the difference between the current and the previous quotations (R$ 89.50 – R$ 90.00) times the number and size of contracts (45 * 33 = 1,300). As prices dropped, we have a negative adjustment of R$ 750.00.
D+2: A positive adjustment of R$ 900.00. (R$ 90.10 – R$ 89.50) * (10 * 33) = R$ 900.00.
D+3: Another positive adjustment with prices hiking. (R$ 91.00 – R$ 90.10) * (10 * 33) = R$ 1,350.00.
D+4: Yet another hike and positive adjustment. (R$ 92.00 – R$ 91.00) * (10 * 33) = R$ 1,500.00.
D+5: Again, prices are up. (R$ 92.78 – R$ 92.00) * (10 * 33) = R$ 1,170.00.
And so on until the expiring date. If prices then reach R$ 93.38, results will be the following:
These adjustments will happen until the maturity date. It is there that we know if the slaughterer will make a profit or loss on the transaction Cattle Future. If at maturity the price of the Cattle close to R$ 93.38, the result is the following:
1.Cattle is purchased for spot prices or R$ 93.38, with a total cost of R$ 140,070.00 (1,500 Arrobas * R$ 93.38).
2. Profits of R$ 5,070.00 from cattle futures after all daily changes accounted (sum of all positives and negatives settlements).
3. Total buying expenses reached R$ 135,000.00, considering the purchase and financial gains (R$ 140,070.00 - R$ 5,070.00). The buyer acts like paying R$ 90.00 per arroba rather than current spot prices of R$ 93.38.
*Taxes and transaction costs have been disconsidered.
- Hedging positions is the top advantage of cattle futures, protecting producers and buyers from price changes and providing them a better way of balancing their cash flow.
- Speculation is a strong possibility and can produce considerable profits, with a relatively small investment. If investors think the price will fall, he may sell future contracts Boi Gordo, without investing money (only the initial margin) with your profit or loss on a daily basis in everyday settings as price variation of Arroba.
- Mini contracts can be also traded, which makes possible for small producers and investors to participate.
- Daily updates;
- Guaranty margin;
- Income taxes;
- Expiry dates, so you cannot undefinedly carry up positions, needing to postpone to a new expiry date if necessary;
- High risk as variable income investment.