Like wolf tracks in the snow, the warning signs have been unmistakable. There's risk out there in the market — big risk. Price volatility in the cattle and corn markets has been the talk at every cattlemen's meeting and coffee shop. While keeping the price wolves from jumping out and biting you isn't easy, cattlemen are looking to the futures market for a red cloak of protection from price volatility.
“Our margins are so slim,” says Joe Scott, manager of Sublette Feeders, Sublette, KS. “We've had to pay more for feeder cattle than we'd like. We've known our breakevens weren't going to be any good. We have to manage our risk a lot better.”
“You need to look at the futures price, and if you can hedge in a $50-$60/head profit, you need to be heavily hedged-up,” suggests Jeff Sternberger, manager of Midwest Feeders, Inc., Ingalls, KS.
For cattle placed on feed in late 2007, the April '08 live-cattle futures contract offered some tempting profit potential. The June '08 board offered options for lighter-weight cattle placed at the same time but finishing later in the spring.
Shane Ellis, Iowa State University livestock marketing economist, says that the red ink seen by some cattle feeders in the fall of '07 “is likely to continue until the second quarter” of '08. That's based on futures-market prices seen in early November. “Producers using a position on the futures market would have their best chance of locking in a profit margin from April to June,” he says.
Beating the breakevens
At Sublette Feeders, customers often partner with the yard in a feeding program. On many of those cattle, as well as company cattle owned by the feedyard, an approximate breakeven is established and a hedging strategy is considered, Scott says.
“I figure a breakeven price, then look at the board to see if it can be hedged at a price I can be comfortable with,” he says. “If I'm comfortable, we go ahead.”
For example, for 168 steers placed on feed in November weighing an average of 841 lbs., Scott figured a breakeven of $97/cwt., based on a 80¢/lb. cost of gain and 115-120 days on feed.
“When we bought those cattle and figured a breakeven, the April futures contract was at $99,” he says. “We were comfortable with that and locked it in.”
Sternberger says some of the cattle that entered Midwest Feeders in the fall had $93-$94 breakevens. “We were able to hedge all those cattle at $100 or more,” he says, providing a nice profit above the $50-$60 range he sought. Those cattle were hedged on the April contract.
“Some additional cattle with upper-$90s breakevens were hedged at $100. We also got some cattle hedged at $94-$95 on the June contract. They went on feed in November and will finish in May with a projected breakeven in the low $90 level.”
Hedges like these are essential, the managers say, with a volatile corn market that could stay steadily above $4/bu. and even approach $5 if the southeastern drought moves northward and/or corn cannot prevent soybeans and wheat from stealing acres.
“You can't be sure what your input costs will be, especially in the winter, so you try to secure what you believe will be a profit,” Sternberger says.
Need is apparent
The need for astute fed-cattle risk management is apparent from Ellis' recent projected sale prices of Iowa finished cattle in '08 and their projected breakeven. Using total sale and input dollars, he says that March should see the year's initial profit potential. He projects a typical finished steer in Iowa to sell for around $100/cwt. with a breakeven point of about $98/cwt.
In April, about a $98-$100 selling price is projected, with the breakeven at $94-$96. But from early summer on, Ellis projects breakevens could be over $98 and possibly as high as $106, while the projected sale prices at that period are likely to be in the $92 and above range.
“We see the steady-to-slightly bullish, year-over-year trends in the Iowa fed-cattle market,” he says. “As for breakeven points past the summer, uncertainty in the '08 corn crop and supply have kept the forecasted breakevens for cattle finishing well above the range of expected sale values.”
What about options?
Scott stays clear of options when possible because of the high cost of premiums. Sternberger also uses futures more than options. But although they can be costly, put and call option strategies can set a solid floor and leave the upside open for market rallies.
Mark Clark, a broker for Professional Commodities Management in Dodge City, KS, says he often combines options with straight hedges. “In many cases, I will go in and sell the board if there's a $35-$55/head profit,” he says. Then he'll wait for the futures price to back up a little bit, say $1-$2.
“After that break in the price, I'll come in and buy a call option at the level near where I sold the futures. With those positions, I protect the cattle and the equity that's producing the cattle.”
He sometimes expands that strategy by selling put options to help lower the cost of the call.
In one deal in November, Clark sold April '08 live-cattle futures at $100. After the market broke back to about $98, he bought a $101 April call, then sold a $92 April put. He was able to lower his call cost to about $1/cwt. With the strategy, he was hedged at $100, yet able to capture a rally if prices shoot above the $101 level, less the $1 cost of the call-put strategy.
“Some think this is a complex strategy with a lot of things going on,” says Clark, who is an introducing broker for Iowa Grain Co. out of Chicago. “But it's actually a pretty simple strategy that again protects the cattle and the equity of producing the cattle. I haven't seen a time the last 1½ years that this strategy didn't benefit the cattle feeder.”
Sternberger says the opportunity to hedge cattle at $100/cwt. was available for at least six straight months for December '07, February '08 and April '08 futures at one time or another in the summer and fall. “All those contracts had prices over $100,” he says. “Even with a negative $1 basis, you could have still assured yourself of $99 cattle for six months. That's a pretty good price.”
“You have to do everything you can to stay ahead,” Scott says, noting that dry weather in the fall sent cattle that would normally have gone on wheat pasture straight to grower yards or feedyards.
“Those cattle may require a different strategy since they likely went on feed lighter. You have to do what you can to cover feeder cattle, corn and fed cattle. Risk management is essential in this environment.”
Larry Stalcup is a freelance writer based in Amarillo, TX.