For producers looking to hedge cattle buying and selling, one of the first decisions they need to make is whether to use Swaps or Futures.

A futures contract is referred to as an exchange traded contract where as a Swap is referred to as an 'over the counter contract'. Futures are traded on a futures exchange with set specifications. Swaps are created by the institution that offers them and can be customised to suit the needs of the buyer or seller.

For cattle in Australia, producers have a choice between MLA/SFE cattle futures and Commonwealth Bank Swaps. A futures contract generally offers better prices and a transparent market, however Swaps are more flexible and do not leave you exposed to margin calls.

The arguments for and against each are:

• For Futures:
  • Better prices
  • Transparent marketplace
• Against Futures:
  • Must pay an initial margin
  • Exposed to margin calls
  • Low liquidity can sometimes make it difficult to trade
  • Can be exposed to slippage when the physical is delivered
• For Swaps:
  • No margin calls
  • More liquidity than futures in far months
  • Flexible timing prevents slippage
  • Often backed off against futures so contribute to futures liquidity
• Against Swaps:
  • Bids are always lower than futures and offers are always higher than futures, ie the bank takes a margin.
  • No market power for the producer if getting out early.

As you can see from these points above, there is not a clear winner and both futures and swaps offer benefits. Generally swaps are easier but futures offer better prices.

In both Futures and Swaps you can place Good Til Cancelled orders, however as the futures exchange is automatic, futures will get traded immediately while a Swap will not be traded until the CBA decides to move their prices.

At the end of the day, futures will give you better prices, while Swaps excuse you from worrying about margin calls. The calculation made in pricing a Swap accounts for the fact that you don't need to worry about finance on margin calls, that you have more flexibility in the specification of the contract and that you can write a Swap to match the timing of the turnoff. The added value of these factors should account for the lower value of the contract. For a cattle producer who wants minimum fuss, Swaps may be a better solution however if you don't mind the odd margin call, futures will offer better prices.

Producers wishing to use either Futures or Swaps should take the above into account and talk to ACU about the most appropriate contract for their situation.