This segment features an explanation of the “Hog Crush”, the relationship between Hog futures and futures on corn and soybean meal, plus an interesting way to play the crush using options. This should be of interest to all serious traders.
The soybean processing term for buying soybeans, crushing them and selling the resulting soymeal and soyoil is known as the crush (there is also a spread trade based on this). Soybeans are “crushed” and are transformed into soybean meal and oil. This term is borrowed by hog hedgers and speculators or the feeding process that transforms small hogs into ones ready for slaughter.
Young pigs (10-50 pounds) are shipped to finishing facilities that grow the animals to 240-270 pounds for slaughter. This takes four to five months and each hog eats almost 1,000 pounds of feed. The feed typically consists of soybean meal and corn. A trader can put on positions that will simulate the feeding process in many respects using a combination of futures contracts on soybean meal, corn and lean hogs,
A hog crush trade that represents the feeding process consists of a purchase of soymeal and corn futures combined with a sale of lean hog futures. The usual ratio for the feed mix is four parts corn to one part soymeal. Four pounds of feed will be converted into about one pound of pork. For example, one contract of soymeal (100 tons or 200,000 pounds) coupled with three contracts of corn (15,000 bushels or 840,000 pounds) will produce the equivalent of seven lean hog futures contracts (280,000 pounds).
The difference between the cost of the meal and corn and the sold finished hog value is known as the Gross Feeding Margin (GFM). Hog producers (farmers) can put on the forward crush and traders can take the other side, the reverse crush. The farmers sell the hog futures and buy the corn and meal and the traders taking the other side do the opposite.
Another way to play the crush is by just using corn and hogs. A chart was displayed of Hogs (/HE) and Corn (/ZC) prices from 2012 to present. A second graph displayed the Hog Crush of 2x /HE minus /ZC. A table displayed the contract specs of Corn (/ZC) and Hogs (/HE). The table included the contract size, tick size, current price, notional and initial margin.
To place the trade one should use corn contracts that are four to five months earlier than the lean hog contracts to account for the amount of time required to feed an animal to slaughter weight. Pete proposed a common Hog Crush spread trade. A table displayed the buy/sell, contract, current price, number of contracts, the notional value, the maintenance margin and the net buying power reduction (BPR) for the trade.
Pete also proposed a Hog Crush spread trade with a theta component by using futures options. This spread was done using hog futures and corn options which are shown on a table along with the current price, notional value, the maintenance margin and the net buying power reduction (BPR) for the trade.
Watch this episode of “Closing The Gap Futures Edition” with Tom Sosnoff, Tony Battista and Pete Mulmat to learn about the hog crush and for a trade idea in this spread.
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