THE CATTLE CRUSH AND REVERSE CRUSH - …

1 1 | THE CATTLE CRUSH AND REVERSE CRUSHWHAT IS THE CATTLE CRUSH ?The CATTLE CRUSH trade seeks to replicate the gross margin of a typical feedlot operation by calculating the spread between input costs and the output sale price. For a typical feedlot, the two primary inputs are feeder CATTLE and corn while the output is live CATTLE , which are sent to market once the feeding process ends. The long CRUSH trade combines taking a long position in feeder CATTLE and corn with corresponding short positions in live CATTLE . The approximate ratio of corn, feeder CATTLE and live CATTLE therefore is as follows: 2 corn and 3 feeder CATTLE to 6 live CATTLE . Calculating the number of contracts to purchase in order to even all legs of the trade requires making some assumptions and it is not perfect. After all, we are talking about live animals that differ in terms of weight and speed at which they reach market weights. The CATTLE CRUSH (and REVERSE CATTLE CRUSH ), or the CATTLE feeding spread, is a trade that is more familiar to feedlot risk managers than financial investors.

2 However, going forward we propose that: The CATTLE CRUSH will continue to have commercial appeal for feedlot operators The CATTLE CRUSH presents a great investment opportunity for investors that are comfortable trading multi contract positions (spreads).In the past, the opportunity that this trade presents as a financial investment has been often overlooked or underappreciated. Livestock and feed markets have become much more volatile in recent years, and this has led to increased use of futures by hedgers and better opportunities for speculators. For hedgers, the trade closely mimics the natural dynamics of the CATTLE feeding industry and is used to minimize operational risk. For speculators, the trade presents significant variability, both intrinsic and seasonal, to make it an interesting investment opportunity. Furthermore, by spreading positions in feeder CATTLE and corn against live CATTLE , lowers the performance bond (margin) required to hold the outright line: The CATTLE CRUSH trade merits further review given the historical potential of the trade and the margin efficiencies that can be those market participants who regularly trade the CATTLE CRUSH , the recent volatility in livestock and feed markets has made the last three months a particularly interesting period.

3 The value of the spread jumped some 54% in a two- week period in January and then pulled back just as much in the last two weeks (see chart), underscoring the potential for profit in the current volatile market environment. THE CATTLE CRUSH AND REVERSE CRUSH : An Industry Hedging Tool And A Financial Investment OpportunityCattle CRUSH : Aug 2014 Live CATTLE 6 Aug 14 Live CATTLE - 3 Apr 14 Feeder CATTLE - 2 May 14 CornDaily Closing Values for the Past Three MonthAll three legs of the trade have been impacted by both the short term drivers led by weather and retail demand as well as the long term undercurrent of a shrinking herd and expanding global demand for : Len Steiner2 | THE CATTLE CRUSH AND REVERSE CRUSHThe CATTLE CRUSH spread for August 2014 Live CATTLE , which is what we showed on page 1, may be calculated as follows: CATTLE CRUSH = (6 * Live CATTLE ) (3 * Feeder CATTLE ) (2 * Corn)On February 25, the closing prices for the specific contracts were as follows:August 2014 Live CATTLE : $ 2014 Feeder CATTLE : $ 2014 Corn: $ This implies the following CATTLE CRUSH .

4 CATTLE CRUSH = (6*400* ) (3*500* ) (2 * 5000* ) CRUSH = $11,108/tradeor $ of live CATTLE (40k lb.) or $ of feeder CATTLE (50k lb.)The size of the live CATTLE contract is 40,000 pounds, which implies a different number of animals depending on their size. For the sake of simplicity, let s assume the average weight of steers by the time they come to market is about 1,335 pounds (in 2013 the Kansas Feedlot Performance survey pegged the average live steer weight at 1,368 pounds while the average heifer weight was 1,228 pounds). This would mean the live CATTLE contract covers 30 live CATTLE . The feeder CATTLE contract size is 50,000 pounds, or 67 head based on an average weight of 750 pounds per feeder CATTLE . Again, for the sake of simplicity, the ratio of live CATTLE to feeder CATTLE in this spread is assumed at 2:1 (2 live per 1 feeder). The 67 head of CATTLE in the feeder CATTLE contract will need to be fed a given supply of corn to bring them to market weight.

5 While each steer is different, a rough estimate is that to feed a steer from about 750 pounds to 1335 pounds you will need about 50 bushels of corn (1 bushel of corn has 56 pounds of corn by definition). And since the size of one corn contract is 5,000 bushels (or 280,000 pounds), it is sufficient to cover the feeding of 100 feeder CATTLE . Calculating the CATTLE CRUSH : An Example3 | THE CATTLE CRUSH AND REVERSE CRUSHIMPLICATIONS OF THE CATTLE CRUSH FOR FINANCIAL INVESTORSWe performed a very limited analysis of the CATTLE CRUSH for four CATTLE CRUSH spreads for 2012 and 2013 (see page 3). In all we analyzed eight different spreads. The results of that analysis are graphically shown on page 3. We started with live CATTLE that would be traded in February, April, June and August and then selected the feeder CATTLE and corn contracts that would best work for the spread trade. The feeder CATTLE purchased is about 5-6 months earlier than the live CATTLE contract while corn will fall somewhere in between.

6 Based on the analysis of these four spreads for 2012 and 2013, the potential returns varied from a little over $9,000 to almost $18,000. Again, this is for a spread that involved three legs of 2 long corn, 3 long feeder CATTLE and 6 short live some investors, the potential return is often viewed in relation to the money required to put the trade on. If bought separately, the margin requirement on the trades outlined above would be:Live CATTLE : $1,013 x 6 contracts = $6,078 ($1,013 is initial margin for 1 live CATTLE contract)Feeder CATTLE : $2,025 x 3 contracts = $6,075 ($2,025 is initial margin for 1 feeder CATTLE contract)Corn: $2,363 x 2 contracts = 4,726 ($2,363 is initial margin for 1 live CATTLE contract)Outright: $16,879As a spread: $5,595**Because the spread trade requires taking both short and long positions, it is eligible for a spread credit. The exact credit would have to be recalculated at the time of the trade and varies depending on both the size of the trade and the months covered.

7 To get some sense as to the margin required for one of the spreads in our analysis, we ran it through the SPAN system. For a spread of 2 Long Corn (March 2014), 3 Long Feeder CATTLE (January 2014) and 6 Short Live CATTLE (June 2014), the initial requirement was $5, , it is worth noting that the spread involves generally liquid contracts. Both live CATTLE and corn are very heavily traded. The volume in the feeder CATTLE market is less, especially for deferred contracts but overall volume still makes this a viable spread trade. 4 | THE CATTLE CRUSH AND REVERSE CRUSHCATTLE CRUSH (2,3,6) DAILY VALUES AND POTENTIAL PROFITS CATTLE CRUSH : Feb 2012 Live CATTLE 6 Feb 12 Live CATTLE - 3 Sep 11 Feeder CATTLE - 2 Dec 11 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11$16,283 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Apr 2012 Live CATTLE 6 Apr 12 Live CATTLE - 3 Nov 11 Feeder CATTLE - 2 Dec 11 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11$12,623 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Jun 2012 Live CATTLE 6 Jun 12 Live CATTLE - 3 Jan 12 Feeder CATTLE - 2 Mar 12 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11$9,118 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH .

8 Aug 2012 Live CATTLE 6 Aug 12 Live CATTLE - 3 Apr 12 Feeder CATTLE - 2 May 12 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-$(5,000)$17,953 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Aug 2013 Live CATTLE 6 Aug 13 Live CATTLE - 3 Apr 13 Feeder CATTLE - 2 May 13 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13$11,013 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Jun 2013 Live CATTLE 6 Jun 13 Live CATTLE - 3 Jan 13 Feeder CATTLE - 2 Mar 13 CornMay 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12$35,000$30,000$25,000$20,000$15,000$10 ,000$5,000$-$9,138 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Apr 2013 Live CATTLE 6 Apr 13 Live CATTLE - 3 Nov 12 Feeder CATTLE - 2 Dec 12 Corn$35,000$30,000$25,000$20,000$15,000$ 10,000$5,000$-May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12$15,123 Time Period is 120 Days from Expiration Month of Feeder CATTLE ContractCattle CRUSH : Feb 2013 Live CATTLE 6 Feb 13 Live CATTLE - 3 Sep 12 Feeder CATTLE - 2 Dec 12 Corn$30,000$25,000$20,000$15,000$10,000$ 5,000$-Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12$12,685 Time Period is 120 Days from Expiration Month of Feeder CATTLE Contract5 | THE CATTLE CRUSH AND REVERSE CRUSHSEASONALITYR ecognizing the seasonality of the CATTLE CRUSH would allow financial investors to focus on those trades that have the biggest profit potential.

9 Moore Research Center Inc. (MRCI) provided us with a list of CATTLE CRUSH trades. Their analysis simplifies the CRUSH even more by using a ratio of 1 Corn, 1 Feeder CATTLE and 2 Live CATTLE but it serves to illustrate the overall profitability of a given spread and the window during which a specific spread is most profitable. For instance, MRCI looked at the following spread: Long April Feeder CATTLE , Long May Corn and Short 2 August Live CATTLE . It identified as the best entry date March 10 and the best exit date as April 4. In the last 30 years, executing this spread during this time period has yielded a profit in 24 of the past 30 years, with an average profit of $1, (see page 6). MRCI provides results of a REVERSE CRUSH trade, as well. For instance, a trade of Short August Feeder CATTLE , Short December Corn and Long 2 December CATTLE with an entry date of July 2 and exit date of July 25 provided a profit in 27 of the last 30 years, with an average profit for winning trades at $ (see Appendix 1).

10 You can find more such trades on the MRCI website: AND OPPORTUNITIESThe CATTLE CRUSH trade goes to the heart of the fundamentals in the CATTLE feeding business. For a feedlot risk management manager, the CRUSH spread provides an opportunity to lock in a margin. Informa Economics issued their assessment of the CATTLE industry and noted that recent positive feedlot margins were unsustainable and their expectation was for CATTLE feeding margins to slip deep into negative territory once again as spring turns into summer. Their argument for eroding feeding margins in the next few months was predicated on two major factors: 1) the recent price spike is a bubble and 2) there is vast overcapacity in the CATTLE feeding business. A financial investor may use the CATTLE CRUSH to either trade this particular view of the market or bet against it. And they can do so at a lower cost than simply buying futures outright. The full analysis from Informa is attached in Appendix 2.