FEEDER CATTLE PRICE RISK MANAGEMENT

DR. CURT LACY

EXTENSION ECONOMIST-LIVESTOCK

UNIVERSITY OF GEORGIA

LET’S TALK ABOUT RISKIt is NOT uncertainty!

It is the negative outcome associated with an unforeseen event.

Good risk managers• Know the odds• Don’t risk a lot to make a

little.• Don’t risk more than

they can afford lose.

DEVELOPING A “GOOD” RISK MANAGEMENT PLAN

1. Identify your major risks

1. Price

2. Production

3. Legal

4. Financial

5. Labor

2. Determine what constitutes a “wreck” for you

3. Learn about the alternatives to minimize or manage this risk

4. Develop and implement a risk management plan

FEEDER CATTLE PRICE RISK MANAGEMENT

GA FEEDER CATTLE PRICES, 2001-2011

01/1

3/01

10/2

7/01

08/1

0/02

05/2

4/03

03/0

6/04

12/1

8/04

10/0

1/05

07/1

5/06

04/2

8/07

02/0

9/08

11/2

2/08

09/0

5/09

06/1

9/10

04/0

2/11

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

$110.00

$120.00

$130.00

700-800# Steers

700-800# Steers

CATTLE PRICING ALTERNATIVES

Delivery Pricing

Auction

Negotiated

Floor Pricing

Options

LRP/LGM

Forward Pricing

Futures Hedge

Auction or Negotiate for

Future Delivery

BASIC DECISIONS

Do nothing

Forward price

• Pre-sell through an auction• Hedge

Minimum price

• LRP• Option

CATTLE PRICING ALTERNATIVES

Delivery Pricing

Auction

Negotiated

DELIVERY PRICING

Two most common forms

• Auctions• Negotiated/private treaty

Easy

No delivery obligation

Highest possible price

Lowest possible price

Risk = high

Reward = high

DELIVERY PRICING EXAMPLE

$110.00

$114.00

$118.00

$122.00

$126.00

$130.00

$134.00

$138.00

$142.00

$146.00

$150.00 $80.00

$90.00

$100.00

$110.00

$120.00

$130.00

$140.00

$150.00

Net Cash Prices at Various Futures Prices Using Delivery Pricing

Cash Price

Futures Price

Net

Cas

h Pr

ice

($/C

wt.)

CATTLE PRICING ALTERNATIVES

Delivery Pricing

Auction

Negotiated

Forward Pricing

Futures Hedge

Auction or Negotiate for

Future Delivery

FORWARD PRICING

Most common forms

• Auction with future delivery• Futures hedge• Negotiated forward contract

Ability to set or at least know what price you will receive.

Advantageous if market is declining

Less than highest price if market goes up.

Risk = moderate

Reward = moderate

MINIMUM PRICING

Most common

• Put options• Livestock Risk Protection (LRP)

Trade small but certain loss (premium) in exchange for protection from uncertain and larger loss (declining market).

Ability to set floor price good in declining market

Ability to get higher price if market goes up.

FORWARD PRICING/HEDGING EXAMPLE

$110.00

$114.00

$118.00

$122.00

$126.00

$130.00

$134.00

$138.00

$142.00

$146.00

$150.00 $100.00 $105.00 $110.00 $115.00 $120.00 $125.00 $130.00 $135.00 $140.00 $145.00 $150.00

Net Price at Various Futures Prices Using a Selling Hedge

Net Price With HedgeNet Price - delivery pricing

Futures Price

Net

Cas

h Pr

ice

($/C

wt.)

“PERFECT” HEDGE – DOWN MARKET

Date Cash Futures Basis27-Apr $ 128.95 Sell futures@ $ 133.95 $ (5.00)

3-Aug $ 115.00 Buy futures @ $ 120.00 $ (5.00)

$ 13.95 Futures Gain (Loss) $ 13.95

Net Price $ 128.95

Currently @ $125

“PERFECT” HEDGE – UP MARKET

Date Cash Futures Basis27-Apr 128.95$ Sell futures@ 133.95$ (5.00)$

3-Aug 140.00$ Buy futures @ 145.00$ (5.00)$

(11.05)$ Futures Gain (Loss) (11.05)$ Net Price 128.95$

CATTLE PRICING ALTERNATIVES

Delivery Pricing

Auction

Negotiated

Floor Pricing

Options

LRP/LGM

Forward Pricing

Futures Hedge

Auction or Negotiate for

Future Delivery

MINIMUM PRICING EXAMPLE

$110.00

$114.00

$118.00

$122.00

$126.00

$130.00

$134.00

$138.00

$142.00

$146.00

$150.00 $80.00

$90.00

$100.00

$110.00

$120.00

$130.00

$140.00

$150.00

Net Price at Various Futures Prices Using Minimum-floor Pricing

Net Price With putNet Price - delivery pricing

Futures Price

Net

Cas

h Pr

ice

($/C

wt.)

PUT OPTIONS:Put Option - gives the holder the right but not the obligation to SELL a futures contract at a set price before the option expires. (Insurance against falling prices). If you will be selling the commodity use a Put

Think of a put option as a price FLOOR

PUT OPTION EXAMPLE – MARKET DROPS

Date Cash Basis27-Apr Buy Put @ $ 130.00 $ (5.00) Option premium $ (3.88)

PUT OPTION EXAMPLE – MARKET DROPS

Date Cash Basis27-Apr Buy Put @ 130.00$ (5.00)$

Option premium (3.88)$ 3-Aug 115.00$ Futures @ 120.00$ (5.00)$

Option Value 10.00$ Option premium (3.88)$

Option Net 6.13$ Net Option 6.13$ Net Price 121.13$

PUT OPTION EXAMPLE – MARKET RISES

Date Cash Basis27-Apr Buy Put @ 130.00$ (5.00)$

Option premium (3.88)$

PUT OPTION EXAMPLE – MARKET RISES

Date Cash Basis27-Apr Buy Put @ 130.00$ (5.00)$

Option premium (3.88)$ 3-Aug 140.00$ Futures @ 145.00$ (5.00)$

Option Value -$ Option premium (3.88)$

Option Net (3.88)$ Net Option (3.88)$ Net Price 136.13$

USING LIVESTOCK RISK PROTECTION (LRP) INSURANCE TO SET A FLOOR PRICE

SPECIAL THANKS TO DR. DARRELL MARK, UNIVERSITY OF NEBRASKA FOR THESE SLIDES

LRP IS PRICE RISK PROTECTION

Establishes A Floor Selling Price For Livestock

Pays Producers If A Regional/National Cash Price Index Falls Below A Set Price

• Does Not Guarantee A Cash Price Received• Basis Risk Must Still Be Considered

Covers Feeder Cattle, Fed Cattle, & Swine

INSURANCE AGENTS

Available Through Crop Insurance Agent System

Agent Locator Tool On USDA Website

http://www3.rma.usda.gov/apps/agents/

COVERAGE AVAILABILITY

Coverage Available About 5pm To 9am CST

• Available Sat Mornings Until 9am, But Not Sun, Mon, & HolidaysCoverage Initiated With Specific Coverage Endorsement (SCE)

• No Limit On Number Of SCEsProducers Have Flexibility On The:

• Timing Of Purchase• Time Length Of The SCE• Number Of Head Covered

LIMITATIONS ON NUMBER OF HEAD INSURED

Fed Cattle

Feeder Cattle

Per Specific Coverage Endorsement 2,000 1,000

Per Crop YearJuly 1-June 30

4,000 2,000

LRP COMPARED TO HEDGING OR OPTIONS

Advantages• No need to establish

brokerage accounts• Can insure animals on

individual basis• “Guaranteed” availability

for price protection for far-off futures contracts

• May be less expensive for deferred months

Disadvantages• Paperwork can take a

while• Available only for animals

in certain states• Can’t “lock-in” a price• Can’t exercise or “sell

back” contract if market goes up

• May be more expensive for nearer months

LRP PRICES FOR 05/23/2011

MINIMUM PRICING EXAMPLE

$110.00

$114.00

$118.00

$122.00

$126.00

$130.00

$134.00

$138.00

$142.00

$146.00

$150.00 $100.00 $105.00 $110.00 $115.00 $120.00 $125.00 $130.00 $135.00 $140.00 $145.00 $150.00

Net Price at Various Futures Prices Using Minimum-floor Pricing

Net Price With putNet Price - delivery pricingForward Pricing

Futures Price

Net

Cas

h Pr

ice

($/C

wt.)

FEEDER CATTLE PRICE RISK MANAGEMENT

DR. CURT LACY

EXTENSION ECONOMIST-LIVESTOCK

UNIVERSITY OF GEORGIA

WWW.SECATTLEADVISOR.COM