CBOT Soybean Complex: An IntroductionCBOT: Soybean ( CBOT:ZS1! ), Soybean Meal ( CBOT:ZM1! ), Soybean Oil ( CBOT:ZL1! )
Today, I am starting a new series on CBOT soybeans, one of the most liquid commodities contracts in the world. In March 2023, Soybean, Soybean Meal, and Soybean Oil together traded 14.0 million lots, contributing to 42.6% of CME Group agricultural futures and options volume, and 2.0% of overall Exchange monthly volume.
Soybean Market Fundamentals
Soybeans are the world’s largest source of animal protein feed and the second largest source of vegetable oil. Soybeans are the most-traded agricultural commodities, comprising more than 10% of the total value of global agriculture trade.
According to the World Agricultural Supply and Demand Estimates (WASDE), global soybean production for 2022/2023 crop year is 369.6 million metric tons. Let’s visualize this: If we were to distribute the entire crops to the world population evenly, each person would get approximately 46 kilograms of soybeans.
The U.S., Brazil and Argentina are the largest soybean producers, accounting for 80% of the global production. The U.S. is the single largest soybean producer and exporter, harvesting 4.3 billion bushels a year and exporting 47% of it, according to the WASDE.
The heart of U.S. soybean production is the Midwest. In the main part of the soybean belt, planting takes place from late April through June, with harvest beginning in late September and ending in late November.
About two thirds of the total soybean crop is processed, or crushed, into soybean oil and soybean meal. The term “crush” refers to the physical process of converting soybeans into its oil and meal byproducts.
The crush spread refers to the difference between the value of soybean meal and oil and the price of soybeans. It represents the gross processing margin from crushing soybeans.
When a bushel of soybeans weighing 60 pounds is crushed, the typical results are:
• 11 pounds of soybean oil (18%)
• 44 pounds of soybean meal (73%)
• 4 pounds of hulls (6%)
• 1 pound of waste (2%)
Soybean meal is used by feed manufacturers as a prime ingredient in high-protein animal feed for poultry and livestock. It is further processed into human foods, such as soy grits and flour, and is a key component in meat or dairy substitutes, like soymilk and tofu.
After initial processing, soybean oil is further refined and used in cooking oils, margarines, mayonnaise and salad dressings and industrial chemicals. Soybean oil may also be left unprocessed and used in the production of biodiesel fuels.
Exports are big business for U.S. soybean farmers. According to the data from U.S. Bureau of Economic Analysis, soybean exports totaled $6.9 billion in the first two months of 2023, contributing to 1.4% of all U.S. exports of goods and services. Soybean exports have increased dramatically since 2000 as the demand for meat and poultry grew in Europe and Asia, particularly in China.
CBOT Soybeans Futures and Options
Soybean futures began trading at the Chicago Board of Trade in 1932, followed by futures on its byproducts: Soybean Oil in 1946 and Soybean Meal in 1947.
Soybean (ZS) futures are physically delivered contracts based on No. 2 yellow soybeans. Each contract has a notional value of 5,000 bushels, equivalent to 136 metric tons. Soybean contracts are listed for the months of Nov., Jan., Mar., May, Jul., Aug., and Sep., projecting out about 3.5 years in the future.
You may have heard of the terms “New Crop” and “Old Crop”. The former refers to crops that have not been harvested. For soybeans, it’s Nov. contract (ZSX3), which coincides with the harvest season. For contract months May, Jul., Aug., and Sep. 2023, soybeans available for sales are from the previous crop year, hence the name “Old Crop”.
Soybean options (OZS) have a contract unit of 1 ZS futures contract. It is deliverable by the corresponding futures contract, with the last trading day set at one month prior to futures expiration month.
Soybean Meal (ZM) futures are also physically delivered contracts. Each contract has a notional value of 100 short tons, equivalent to 91 metric tons. Soybean Meal contracts are listed for the months of Jan., Mar., May., Jul., Aug., Sep., Oct., and Dec. A total of 25 contracts are listed simultaneously. Because of the use of soybean meal for animal feed, its demand is closely aligned with the livestock and poultry industry. For the export market, instead of soybean meal, buyers usually buy soybeans and process them in their home country.
Soybean Meal options (OZM) have a contract unit of 1 ZM futures contract and are deliverable by the corresponding futures contract.
Soybean Oil (ZL) futures are physically delivered contracts. Each contract has a notional value of 60,000 pounds, equivalent to 27.2 metric tons. Soybean Oil contracts are listed for the months of Jan., Mar., May., Jul., Aug., Sep., Oct., and Dec. A total of 27 contracts are listed simultaneously. While soybean oil is a leading ingredient for edible oil, oilseeds also include rapeseed, sunflower, sesame, groundnut, mustard, coconut, cotton seeds and palm oil. Whenever one of them becomes too expensive, food companies would substitute it with a cheaper ingredient. Hence, soybean oil price is highly correlated with the other oilseed products.
Use Cases for CBOT Soybeans Contracts
At every stage of the soybean production chain, from planting, growing and harvest, to exporting and processing, market participants face the risk of adverse price movements. Prices of soybean and its byproducts continuously fluctuate, largely determined by crop production cycles, weather, livestock production cycles, and ongoing shifts in global market demand.
In this section, I will illustrate how producer, storer, processor and soybean user could use CBOT soybeans futures and options to hedge market risks.
Soybean Farmer (Producer)
When a US soybean farmer plants the crops in April, he is said to have a Long Cash position. The farmer is exposed to the risk of falling soybean price during the November harvest season. To hedge the price risk, our farmer could enter a Short Futures position now, and buy back and offset the futures when he is ready to sell the crops.
Since the cash market and futures market are highly correlated, loss or gain in the cash market will be largely offset by the gain or loss in the futures market. The farmer is left with basis risk, which is adverse changes of the cash-futures spread. It is usually much smaller than the outright price risk. In the context of futures trading, notably commodities, basis refers to the difference between the spot (cash) price of a commodity and the price of a futures contract for that same commodity.
Grain Elevator (Storer)
After the crop is harvested, farmer or merchandiser would usually store the soybeans in a grain elevator and wait for the right time and price to sell. Soybeans could be stored for a year but would incur monthly storage costs. The decision to store depends on whether expected future price gains outweigh the storage costs.
The merchandizer is exposed to the risk of falling soybean price, which would cause his soybean inventory (old crop) to decline in value. To hedge the price risks, he could establish a Short Futures position for the expected period of storage and buy it back when he is ready to sell.
Oilseed Processor
For soybean processing mill, crush spread represents the gross processing margin from crushing soybeans. It is exposed to the risk of rising soybean price where meal and oil prices fail to catch up.
Soybeans trade in bushels, soybean meal trades in short tons and soybean oil trades in pounds. The prices of the three commodities need to be converted to a common unit for an accurate calculation. A bushel of soybeans produces about 44 pounds of soybean meal. Since Soybean Meal futures are priced per ton, multiplying the meal price by 0.022 represents the meal price per 44 pounds. That same bushel of soybeans also produces 11 pounds of soybean oil. Since Soybean Oil futures are priced per pound, multiplying the soybean oil price by 0.11 represents the oil price per 11 pounds. (www.cmegroup.com)
Processor could lock in the crush margin by a crush spread trade. To ease the difficulty of constructing and executing the spread, CME Group facilitates the board crush that consists of a total of 30 contracts; 10 Soybean, 11 Soybean Meal, and 9 Soybean Oil.
Livestock Farmer (User)
Large-scale farms usually buy corn, soybean meal and other ingredients to produce their own feed. Farmers are exposed to the risk of rising ingredient costs. They could hedge the price risk by establishing long positions in CBOT corn and soybean meal futures.
For hog farmers, gross production profit is represented by the Hog Crush Margin. It is defined by the value of lean hog (LH) less the cost of weaned pig (WP), corn (C) and soybean meal (SBM). In the futures market, traders could replicate the economic hog crush margin with a Hog Feeding Spread involving CME lean hog (HE), CBOT Corn (ZC) and CBOT Soybean Meal (ZM). There is no futures contract for weaned pig (piglet).
If you expect hog margin to grow, Long the feeding spread: Buy lean hog, sell corn and soybean meal. For a shrinking margin, Short the spread: Sell hog, buy corn and meal.
This concludes Part 1 of our introduction to CBOT Soybean complex. In Part 2, I plan to discuss major reports that move the soybean markets:
• World Agricultural Supply and Demand Estimates (WASDE)
• USDA Prospective Plantings Report
• USDA Grain Stocks Report
• CFTC Commitment of Traders Report
Happy Trading.
(To be continued)
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
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