It seems like this swine flu is part of almost every story on the news at the moment. It is however interesting to step back and take a look at how it has affected the market – the Lean Hogs futures market traded out of Chicago.
There are two ways news like this affects a futures market: outright prices and spreads between contract months.
Firstly how the news has affected outright prices is pretty obvious. Despite zero evidence that US livestock is affected, prices for Lean Hogs gapped lower on Monday. This is because the affect the flu will have on demand for all pork products. For those short the market, it’s been a windfall, but when a market moves that quickly, it is very hard to get in or out, particularly as the price you want.
With general uncertainty surrounding what will happen in coming weeks, prices remained low over the week, but did not move to far in one way or another. See chart below.
The news of the flu also impacts spreads – that is the price of one contract month versus the other. Have a think about how it would affect the spread price. Would each contract month move in the same direction? Yes. By the same amount? Highly unlikely.
The nearer expiry months tend to be impacted more when this kind of news hits the market. That is because traders assume the issue will be cleaned up and contained within a shorter period of time rather than longer.
So for Lean Hogs last week, prices for all contracts fell, but the nearer to expiry fell further. The ProTrader Digest site had recommended buying the August and selling the July contract just before the news hit. Even the spread with expiry months only one month apart showed a terrific move. See chart below. In the last week, the August-July spread has moved just less than 2 points (at $400/point).
Interestingly the December versus July spread showed an even greater move (given the greater distance between expiry months). This spread has moved 2-3 times the August-July spread.
Overall, this recent news shows how spreads can work very well and, for the most part, carry less risk than trading the outright position.
Best regards and good trading,
Guy Bower ProTrader LLC Guy@ProTraderDigest.com
