Livestock industry participants have faced high volatility in Lean Hog markets in recent years, driven by supply chain disruptions, animal diseases, and uncertain demand. 

With no clear end to the volatility generated by the changing economic landscape, livestock market participants look to minimize downside risk and protect potential profits on their Lean Hog exposure from adverse price moves in the most cost-efficient way possible.

While an outright option strategy is one way to achieve viable, cost-effective risk management, an option spread strategy –  an options position that involves buying or selling multiple strikes and/or expirations on the same commodity – can provide more flexibility, lower costs, reduce margin requirements, and still offer specific protection tailored to certain risk management characteristics. Specifically, a vertical put option spread strategy can be used to mitigate risk with a defined risk/reward profile. 

A vertical put spread is an options strategy that involves buying a put at a certain price and simultaneously selling a second put at the same expiration but at a different strike price. This strategy allows the user to hedge downside risk while reducing the up-front cost of the strategy. The upside of this trade is limited at the strike price of the second leg, while the downside is limited by the strike price of the first leg. The put spread allows for coverage up to the short strike. If futures drop below the short strike, the put spread does not offset any losses in the cash market.

It is early August 2025 and a hog producer plans to sell 2,000 hogs, each with an estimated carcass weight of 205 pounds, at some point in the next two months. The producer is concerned that the price of hogs will fall before selling, so in order to protect against downside price risk, the producer implements a vertical put spread strategy. December Lean Hog futures are currently trading at 84.000 cents per pound, a price the producer would like to receive.

Date: Early August 2025
December Lean Hog Futures Price (cents per lb): 84.000
Physical Position: 2,000 hogs for a total carcass weight of 410,000 pounds
Spread Strategy: Vertical Put
Leg 1: Buy 10 Puts @82.000¢ for $3.653 premium
Leg 2: Sell 10 Puts @78.000¢ for $2.263 premium

In early August the producer initiates a vertical put strategy using December Lean Hog Options, which settle into the December Lean Hog futures contract. Because the producer’s spread strategy hedges against relative downside price movement, the producer chooses a nearly at-the-money strike price for the buy-side leg of the spread. The strike price for the sell-side leg of the spread represents the lower limit of the producer’s downside protection. In a vertical put spread, the greater the difference between the strike prices of the two legs, the greater range of protection the spread provides. The cost for a vertical put spread, as represented by the sum of the premiums paid for the buy-side leg and received for the sell-side leg increases as the range of protection provided by the spread grows. Here, the producer is paying $1.390 (paying $3.653 for the buy-side leg of the spread and receiving $2.263 for the sell-side leg) and will start to receive protection for prices below $82 with a maximum payout of $2.610 for prices $78 or lower. Executing only the buy-side leg of the spread would provide unlimited downside protection but at a higher cost than for a vertical put spread, where the sale of the second leg offsets some of the cost of the first leg. 

In early December the December Lean Hog futures contract is trading at 78.000. The 82put (the first leg) that the producer bought is worth $4.00 per contract. Because the producer paid an initial premium of $3.653 for this option, the net profit on this leg would total $0.347. Also at 78.000 December futures, the 78 put that the producer sold (the second leg) would be near expiration and only worth a few cents, creating a near $2.263 profit for the premium initially collected when the spread was implemented. The vertical put spread thus nets the producer a profit of $2.610 per contract.

This profit on the spread would soften the producer’s losses in the physical market. The producer’s execution of a vertical put spread in this scenario provides protection of $10,440 of a $24,000 loss that the producer suffers in the physical market.

During periods of heightened volatility, option premiums are driven higher. Using one part of an options spread strategy to fund the other, vertical put spreads offer downside coverage at more affordable premium costs vs. an outright put. The table below shows the difference between the cost of the vertical put spread relative to buying an outright 82 Put for $3.653.

Our cautious hog producer is able to hedge his Lean Hog exposure cost-effectively by using a vertical put spread to manage his downside price risk exposure.