Lean HogsTrading

Lean hog futures trade at CME Group in the livestock futures complex, which also includes live cattle, feeder cattle and pork belly futures. The standard trading unit for lean hog futures is 40,000 pounds.  One trading point equals $0.01 per hundred pounds or $4.00 per point. Minimum price fluctuations are in multiples of $0.00025 per pound, or $10.00 per “tick”. Contract months are February, April, June, July, August, October and December.

Lean hog futures contracts are cash-settled to the CME Lean Hog Index, a two-day weighted average of United States Department of Agriculture (USDA) cash prices for producer-sold swine or pork market formula transactions.

Lean hog futures trade at CME Group in the livestock futures complex, which also includes live cattle, feeder cattle and pork belly futures. The standard trading unit for lean hog futures is 40,000 pounds.  One trading point equals $0.01 per hundred pounds or $4.00 per point. Minimum price fluctuations are in multiples of $0.00025 per pound, or $10.00 per “tick”. Contract months are February, April, June, July, August, October and December.

Lean hog futures contracts are cash-settled to the CME Lean Hog Index, a two-day weighted average of United States Department of Agriculture (USDA) cash prices for producer-sold swine or pork market formula transactions.

Most U.S. hog production occurs in the Midwest near the source of hogs’ main feed supplies, corn and soybean. The largest hog producing states are Iowa, North Carolina, Minnesota and Illinois.

Normally, it takes about six months from the time of birth for a pig to reach slaughter weight of 230-260 pounds. At 250 pounds live weight, a hog will yield 88-90 pounds of lean pork consisting of about 20-21 percent each for ham and pork loin, 14 percent for the pork belly or bacon cut, 3 percent spare ribs, 7 percent Boston butt roast and blade steaks and 10 percent picnic. The jowl, fat and other trimmings are used in a variety of meat products and the hide for leather. Everything on the hog is used except for the squeal, according to one expression.

Hog prices seasonally tend to be highest between May and July when the number of market hogs is usually the lowest and meat distributors are starting to accumulate supply for the bacon-lettuce-tomato sandwich season and for freezer storage for the winter.

Lean hog futures traders need to watch the price of corn because that is the main ingredient in hog feed rations. If the price of corn rises substantially, hog producers will be more inclined to take their hogs to market at lower weights to reduce high feed costs. That typically causes lean hog futures prices to decline initially as more supply becomes available, but it eventually should result in a smaller hog herd, lower pork supply and higher prices.

The relationship of lean hog and corn prices is so intertwined that a lean hog futures trader can monitor the hog-corn ratio to get a simple but sound indication of developments in hog production. This ratio just divides the price of lean hog futures by the price of corn futures. In the past, the dividing line for the hog-corn ratio was about 14 – a ratio larger than 14 would encourage hog producers to increase hog numbers and a ratio less than 14 would be likely to cause hog producers to decrease hog numbers. That dividing line in recent years has gotten closer to 18-20, as more than 40 percent of total U.S. hog production is now on a contract basis where the producer now just provides the labor for a large commercial hog operation that doesn’t have the same flexibility to adjust numbers as the individual hog producers of the past did.

The major report for the lean hog futures trader is the Hogs and Pigs report released by USDA near the end of each quarter. The report includes data on the size of the total U.S. hog herd, the size of the pig crop, a breakdown of market hog numbers into several weight categories, the size of the breeding herd, the number of sows farrowed in the previous months, pigs per litter and hog producers’ farrowing intentions for the coming months.

The lean hog futures trader should also be closely monitoring the CME Lean Hog Index, a two-day weighted average of cash prices. Beginning in 2003, the cash prices used in the index became the average net prices at the average percent lean for slaughtered hogs. USDA releases these price reports and other data daily.

USDA provides a number of other reports of interest to lean hog futures traders including daily slaughter totals and the monthly Livestock Slaughter report, which presents statistics on total hog slaughter by head, average live and dressed weight in commercial plants by state and in the United States and other slaughter data.
Several reports published by USDA’s Economic Research Service, including Livestock, Dairy and Poultry Situation and Outlook and Red Meat Yearbook, give data on imports and exports of lean hogs, offering monthly, quarterly, and yearly statistics that are separated out by selected countries by carcass weight and live animal elements.

Extension services in a number of hog-producing states also provide a large amount of material on all phases of hog production and on the economics of the hog industry.

All of the numbers contained in the Hogs and Pigs report make if possible for the lean hog futures trader to calculate the amount of pork supplies in the future by analyzing the breakdown of market hogs by weight and add estimates of how long it will take these market hogs to reach the weight at which they will be sent to the packing plant. Deviations from the percentage change in hog numbers and the percentage change in slaughter figures from the previous year may indicate that there was some error in the estimates or that the numbers of hogs are being increased or decreased for economic reasons.

The number of newborn pigs should also help the lean hog futures trader gauge the amount of hog slaughter and pork supplies about six months later. Once pigs are born, they will go through the biological cycle of weaning, feeder pig and market hog stages and will be sold at some price. They are not a storable commodity other than the relatively short period they may have in freezer stocks after slaughter. Knowing the amount of supply that must move through the food pipeline at some price can help the lean hog futures trader plan a trading strategy.

Hog producers often use marketing contracts to sell their lean hogs directly to packers. Types of marketing contracts include fixed price, fixed basis, formula price, cost plus, price window, and price floor.  It is important to mention that when hogs are priced, it is usually with regard to the actual percent lean of their carcasses, because it is this percentage that determines the actual amount of meat the carcass will yield. When live hogs are sold at an auction, however, the price is based on an expected percent lean.

Instead of becoming involved directly in the hog business by trading lean hog futures, an investor could purchase shares of companies that are heaving involved in commercial hog operations such as Smithfield Foods or Tyson. Knowing about lean hog production and marketing would be helpful in evaluating the prospects for such companies.

The lean hog industry has seen dramatic changes during the last decade due to a move to contract and vertically coordinated production. This move was partially spurred by an effort to maintain control of the growth process and to improve production, efficiency and lean hog profitability. 

Another development in recent years has been the increase in pork exports. The United States is the world’s largest pork supplier, and the export market could become a more significant price influence if countries like China increase pork imports. China is a large hog producer itself but is also a major consumer of pork, and the size of its population and improving diets could mean a big boost in pork demand.

Trading in live hog futures began at CME in 1966. At that time the contract called for 20,000 pounds of hogs delivered to terminal facilities. Options on live hog futures were introduced in 1985. Over the years the contract has evolved to better serve market users, increasing the size of the contract to 40,000 pounds in 1991 to match the size of the live cattle futures contract. The name of the contract was changed to lean hog futures in 1997, when lean hog futures contracts became cash-settled to the CME Lean Hog Index. Since 2002, lean hog futures contracts have been traded in both the traditional open-outcry setting and electronically.