Answer :
When we purchase live cattle, the price of live cattle is not stable, it changes every day due to several factors such as supply and demand, weather, government regulations, and other economic factors.
Therefore, we have to sell CME Live Cattle futures contracts to hedge the purchase.To hedge the purchase of 95 head of live cattle or about 122,000 pounds, we will need to sell one CME Live Cattle futures contract. One contract represents 40,000 pounds, therefore, 3 contracts will cover the entire purchase of 122,000 pounds.In order to sell the CME Live Cattle futures contract, we must have a margin account with a futures brokerage firm. A margin account is a deposit of funds that acts as collateral for a futures contract.
This deposit is usually 10% of the total value of the contract. The value of the contract is calculated by multiplying the contract size by the current futures price. When we sell the CME Live Cattle futures contract, we will receive cash in the amount of the sale price and this amount will offset any losses in the purchase of the live cattle. In conclusion, to hedge the purchase of 95 head of live cattle or about 122,000 pounds, we need to sell 3 CME Live Cattle futures contracts.
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