Livestock Futures and Feeding Margins

A cattle feedlot buys young feeder cattle, feeds them corn and soybean meal for months, and sells the fattened animals as live cattle. Its profitability is a three-legged spread: the feeding margin is the sale price of fat cattle minus the cost of the feeder cattle bought and the feed consumed to fatten them. Because futures exist on feeder cattle, live cattle, and corn separately, a feedlot can lock in this margin ahead of time by trading all three legs, rather than hoping cattle and grain prices move favorably on their own.

Worked example

A feedlot buys a feeder calf for $1,200 and expects to spend $800 on corn and soybean meal to bring it to slaughter weight, for total input cost of $2,000. If live cattle futures suggest the fattened animal will sell for $2,300, the expected feeding margin is $300 per head. By locking in feeder cattle, corn, and live cattle futures at today's prices, the feedlot secures that $300 margin regardless of how each individual price moves before the cattle are actually sold.

In practice few feedlots hedge every leg perfectly, since feeder cattle, corn, and live cattle futures don't always move in the ratios a given operation's actual biology requires — so some residual margin risk usually remains even after hedging, just far less than if none of the three legs were hedged at all.