Limit Risk On Stockers

March 25, 2010 07:26 AM
 


 

Calculators & Spreadsheets

Feeder Cattle Bid Calculator (Online Excel spreadsheet) Iowa State University

Click here to read "Managing Cattle Price Risk with Futures and Options Contracts" from John Lawrence, Iowa State University

Livestock Enterprise Budgets for Iowa — 2010 (Breakeven worksheet)

Source Web sites:

From 2002 to 2006, cow–calf producers were the one profitable segment in the cattle industry, according to data from CattleFax. That trend, however, is taking a turn. Cow–calf producers no longer have an automatic advantage when marketing calves.

There are, however, ways to limit risk when it comes time to market calves, says Brett Stuart, CattleFax analyst. His suggestions:
 

  • Consider two pricing windows for calves. This allows you to market calves in two time periods to avoid taking a hit should prices fall. Half could be priced in July or August and the rest priced later in the fall, when they are delivered.
  • Watch market seasonality. Typically, 550-lb. steer prices peak in March and April and bottom in November. If you can't adjust production cycles to accommodate, forward contract in the summer before seasonal lows.
  • Have a plan B. There has been a collapse in fall calf and feeder prices in the past two years. Have a backup plan if you retain ownership.
  • Backgrounding and preconditioning are management protocols that pay if you retain ownership on calves. That's because you get the additional health benefits and improved gains from the calves. If you sell the calves, advertise the added value to buyers.
  • Run summer yearlings if you have available forage. This works eight out of 10 years, Stuart says. (See the chart below.) The key is to know your break-even cost of production and use seasonal futures to forward contract. Manage for return over investment, not necessarily profit.


Forward contracts. "Producers have many options to take advantage of seasonal volatility in the feeder cattle market,” adds Justin Gleghorn, market analyst for Brock Thompson Trading in Amarillo, Texas.

Normally the Chicago Mercantile Exchange feeder cattle contract reaches a high in the summer and trades lower through the end of the year.

"If a producer will be selling feeder cattle in a declining market, then a short hedge strategy can be implemented, whereby a short position is taken in one of the fall contracts:

August, September, October or November,” he explains. "The decline in cash price can be partially offset by gains made from the short hedge, basis adjustments accounted for.”

Producers can also use options, where they can buy a put—which is the right, but not the obligation, to take a short position in the market at a given price in a given month—for a premium.

"The premium paid for the option is the producer's maximum risk,” Gleghorn explains. "If the futures market is trading above the strike price of the option when the option expires, the put will expire worthless and the producer's loss will be the premium paid for the put.

"However, if the futures market is trading below the strike price, the producer can elect to establish a short position at the strike price of the put and then take advantage of the declining market.” When using this strategy, you need to account for the premium paid for the put and include it in break-even calculation. BT




To contact Kim Watson-Potts, e-mail kwatson@farmjournal.com.

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