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CME Group adds ag contracts
Based on solid industry acceptance of weekly grain options, the CME Group expands its suite of specialty agricultural contracts Monday with the launch of weekly options on cattle, soybean meal and soyoil.
Meal and oil options started electronic trading Sunday, and weekly cattle options joined them Monday. All are traded in open outcry (pit trading) and on Globex, an electronic trading platform.
Meal, oil and cattle complement existing weekly options for wheat, corn and soybeans, which began trading in May. The CME also offers calendar spread options (CSOs) on selected agricultural futures, essentially combining a two-futures spread trade into one options contract.
Weekly Grain Options (WGOs) for corn, wheat and soybeans were launched May 23, and have posted more than 172,000 trades in their first four months.
"We’re pleased with their strong performance," says Tim Andriesen, the CME's managing director for agricultural commodities and alternative investments. “Weekly options on agricultural futures are a new innovative product that have changed the rules of the game in agricultural commodities."
Contracts Expire Weekly
Weekly listings mean, for cattle and grains, there is now an options contract expiring every Friday of the year. (If Friday is a holiday, expiration falls on the previous business day.)
The CME has long offered "standard" options, which track the futures months. That is if there's a September futures, there's a September option. If there's no October futures, there's no October option. At least not a traditional "standard" option.
Since futures are staggered -- skipping some months -- the CME added "serial" options several years ago to fill in the missing months. These "fill-in" options are listed only when a futures contract is within a couple of months of expiration.
Weekly options fill in the last month of a futures contract's life with an option contract that expires every Friday. The result is that the last month of trading for a given futures contract shows at least four options expiring on successive Fridays. Three of those options are new "weekly" listings, and the other one is a previously existing "standard" or "serial" option.
Although the contract specifications for all 52 weeks are the same, there's a key difference between the expiration of a standard option and a weekly option. Weekly options that expire after a standard option are assigned a different underlying futures contract.
For example, says Andriesen, July futures expire in July, but the July standard option (exercisable into July futures) expires in June. Even though there are some weeks left until the July futures expire, no more options will exercise into the July futures. Once the July standard option expires, subsequent weekly options are exercisable into the September futures -- even if they were listed before the standard option expired.
Andriesen says the CME does this to avoid complications with the delivery period and "first notice day" for the nearby futures.
Low Cost Price Protection
Weekly corn, wheat and soybean options have proven popular because the price is low, due to the short remaining time premium. This has made weekly options attractive for placing low-cost trades before weekends, around key crop-weather forecasts, and before market-sensitive events such as USDA reports.
Corn attracted the bulk of the summer's weekly option volume as traders placed bets and hedged supplies ahead of USDA's tight carryover numbers. Short-duration options can also be placed to hedge against possible crop weather changes in the days and weeks ahead.
Farmers might use them to provide low-cost price protection around the volatile planting and harvest seasons, possibly even the corn-pollination season. If there's a three-week "heat dome" building over the Midwest, there's a three-week option to match.
For cattle, traders can use these "event-driven" weekly options ahead of key corn reports, plus USDA's monthly cattle-on-feed report (as well as the semi-annual cattle inventory).
One of the new cattle options just listed this morning expires on Oct. 14. It can be used to hedge sharp moves in cattle prices that might result from USDA's Oct. 12 crop report. Another option expires on Oct. 28. It can be used to mitigate surprises in USDA's Oct. 21 cattle-on-feed report. (There's also an option on Oct. 21, but it expires just minutes before USDA releases its monthly cattle report.)
An example of how the weekly calendar is structured can be seen in this example starting with today's new weekly cattle options: (the procedure is essentially the same for grains)
* The CME today lists three new weekly cattle options. One will expire this Friday, Sept. 30. It will be exercisable into the October live-cattle futures. The other two options will expire on Oct. 14 and 21.
* A week from today, the exchange will list a new weekly option, expiring on Oct. 28.
* On Friday, Oct. 7, a "standard" option will expire. It's been trading for a full year, and since that time it's been exercisable into October 2011 cattle futures.
* After Oct. 7, weekly cattle options will be exercisable into the December futures -- until Dec. 2, when another "standard" option expires and the underlying futures becomes the February contract. This change in the underlying futures occurs every time a standard option expires.
* On Friday, Nov. 4, another cattle option expires, but the CME calls this a "serial" option. It's been listed since Sept. 6, so it's older than a weekly option but younger than a standard option. It's a monthly "fill-in," for months when futures contracts don't expire. It's called the "November" option, and it is exercisable into the Dec cattle futures.
* After the Nov serial option expires, three more weekly cattle options will exercise into the Dec futures until the Dec standard option expires on Dec. 2.
* December has five Fridays, requiring four weekly options during the month (plus the aforementioned Dec standard option). All four weekly options during December exercise into the Feb futures.
* Feb futures will be the underlying contract for all cattle options until Jan. 17, when April applies. The cycle continues. March has five Fridays, so it gets four weekly options and one serial option. (That serial option doesn't start trading until Jan. 9.)
Calendars for all the commodities can be found on the CME's website.
Like the CME's existing futures and options, today's new weekly cattle options cover 40,000 pounds of slaughter-ready cattle. The soymeal contract covers 100 tons, a soyoil option trades 60,000 pounds.
The buyer of a weekly call or put option may exercise the option at any time before expiration. This is known as an "American-style" exercise. It contrasts with European-style options, where holders may exercise only at expiration.
Options that expire "in the money" are automatically exercised, unless the holder specifically opts out. Options that expire exactly "at the money" are not exercised automatically.
The CME has not listed a weekly hog option, possibly because USDA's hog-herd reports are only quarterly. In addition, hog prices do not seem as sensitive as cattle to USDA's corn numbers.
"We will continue to monitor the market to determine whether there is demand for weekly options in the CME's lean-hog futures, but at present the primary interest in livestock is for live cattle," says exchange spokesman Chris Grams.
The CME's research staff often measures market interest to see if new products should be developed to serve a given industry -- and if those contracts will attract sufficient trading volume.
Participation by farmers -- not just exporters, processors and floor traders -- is important to the CME. The economists and statisticians who develop these contracts spend a lot of time trying to tailor the products to attract both buyers and sellers, in roughly equal amounts, says Fred Seamon, who participates in that effort in his role as associate director for commodity research and product development.
"When we research an industry for new trading products, we like to find what we call 'natural longs' and 'natural shorts'," he says.
One such new product is Soybean-Corn Ratio Options. If corn is $7 and soybeans are $14, the Soybean-Corn Ratio is 2. With this new option, you can bet on whether that ratio will widen or narrow. It doesn't matter whether prices generally go up or down, your bet is on the spread between corn and soybean prices.
Seamon expects activity in these options to pick up in the winter and spring when corn and soybeans are competing for acres.
Corn, Soybean VIX
Another new product that's not a tradeable contract yet is VIX, which is an index of volatility. This summer the CME began computing a VIX for corn and soybeans. This is a general volatility measure of the corn and soybean markets, based largely on the implied volatility for individual option contracts. Each option has its own implied volatility, and VIX is computed by combining those individual measures.
Traders call VIX a measure of interest in the market. If there's a lot of volatility, it can suggest that there's a lot of fear and uncertainty in the market. If volatility is low, it suggests complacency among market participants. Some advisers suggest that when fear or complacency reaches its extremes, the mood is about to shift. VIX allows one to measure those moods.
Corn and soybean futures/options begin trading at 9:30 each weekday. Based on that trade, the exchange starts computing VIX at 9:45 a.m., and updates it every 15 seconds. Seamon says the CME is looking at developing a wheat VIX, and it's possible that the exchange may develop tradeable VIX contracts for these grains.
Calendar Spread Options
Calendar Spread Options (CSOs) are also attracting volume in Chicago. They track the difference between two different futures months, such as July and November soybeans or September and December corn.
The CME also offers calendar-spread options for hogs and cattle.
Marketing strategies have long involved a "spread" trade that buys or sells a nearby futures while establishing an opposing position in a deferred contract. CSOs allow predetermined spreads to be established with just one option purchase.
Grain elevators can use these options to hedge stored grain, and farmers can use them to hedge grain in storage or in the field. But the biggest users might be big commercial buyers of grain.
"Crops are harvested just once a year, but processors need their grain deliveries spread out across the calendar. Futures prices are used to help allocate that crop across the entire year, but not without risk," says Seamon.
"Now with these new CSOs, processors or any one else exposed to that 'calendar risk' can utilize an options strategy to help hedge that risk."
In contrast to the once-a-year harvest of crops, livestock reach slaughter weight every day. But calendar-spread options are still finding use in the livestock pits to hedge against price differences when rolling from an expiring futures into a new month. And you can make a speculative bet that nearby cattle/hogs will gain on the deferreds by buying a call. You can bet that deferred cattle/hogs will gain on the nearbys by buying a put. It doesn't matter whether absolute prices go up or down, your bet is on the spread between nearbys and deferreds.
Calendar spread options combine a traditional two-futures buy/sell spread into a single option trade. And as an option buyer, you have no margin calls.
Exercise of livestock calendar options is European-style, which means that exercise occurs only at expiration. If you exercise a "call," you end up owning one nearby futures while being short a deferred futures. If you exercise a put, it's reversed: You end up short a nearby futures and long the deferred futures.
Written by Andre Stephenson, a freelance writer for Successful Farming and Agriculture.com.