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Riding The Winds

Been trying to keep up with feeder-cattle futures lately? If you have, and you're not sitting down, best find a chair, because the volatility can be dizzying. It can also be rewarding. With feeder-cattle markets in the mid-teens and a tight supply of calves over the horizon, the much-needed high prices the Chicago board has produced may just stay that way. Tom Jessop thinks so, but he wants to make

Been trying to keep up with feeder-cattle futures lately? If you have, and you're not sitting down, best find a chair, because the volatility can be dizzying.

It can also be rewarding. With feeder-cattle markets in the mid-teens and a tight supply of calves over the horizon, the much-needed high prices the Chicago board has produced may just stay that way.

Tom Jessop thinks so, but he wants to make sure. The Dalhart, TX operator is always ready to lock in the prime prices by using feeder-cattle futures, but he won't hedge at just any price. And he won't pull the trigger without analyzing trends he sees in the industry.

Jessop is involved in nearly every aspect of beef production. He runs a moderate-sized cowherd, pastures yearlings, feeds many of them out and is an order buyer for Caviness Beef Packers in Hereford, TX.

“I usually feed about 70% of the yearlings,” says Jessop, who's seen his share of market ups and downs, from the '73 wreck on. “The other 30% are often hedged when there's a profit on the table.”

He was seeing good hedging opportunities in mid-summer for calves that will be ready as yearlings this fall and early next year. Futures prices in the $113-$116/cwt. range, with $118 close by, had him ready to sell Chicago Mercantile Exchange feeder-cattle futures.

“In the last two years, when prices have been pretty good, $118 has been as high as the market got,” says Jessop, whose wife Jodie helps with their operation's risk management. “Even with a shortage of placements in the spring and summer, I can see placements being a little higher in the fall.”

That could mean pressure on feeder prices. “So instead of waiting until the fall to market them, I'll hedge them a little earlier than usual at about $118 when I can.”

He'll likely use multiple contract months to match staggered sales. “We'll probably move cattle when they're in the 700- to 800-lb. range,” he says. “I'll probably hedge on a graduated basis, and will lift hedges as I sell the cattle.”

Volatility rules

Jim Mintert, Kansas State University livestock marketing specialist, says the volatility in cattle markets this year indicates producers should take advantage of higher prices when they can.

“It's a tough market to call,” Mintert says. “My advice is to sell the rallies in this environment. Those kinds of prices (the $115-$118 range) look attractive. I think there's very little upside potential from those levels.”

He says that when corn prices shot above $7 and approached $8, fed-cattle markets followed suit. That helped ease the pressure on feeder prices, he says, because feeders were pulled up by the fats.

And when corn prices dropped into the low-$6 range in mid and late July, it apparently caused fed-cattle prices to back off $8-$10 to about $1.05. It also threatened to drag feeders down with it. But with high volatility in both cattle and corn prices, markets were just as likely to rally again as not, meaning protection on both ends is necessary.

Darrell Mark, University of Nebraska livestock marketing specialist, also says downside protection should be considered when markets are high. “When you look back at the weekly charts, we've only surpassed $115/cwt. twice in the past two years, once in July-August of 2006 and again in July-August of 2007.

“In both cases, $120 was the high,” Mark says. Seasonally, we're approaching what is typically the high, he says, but cautions it's always a bit dangerous to assume seasonal trends will continue to hold.

“Second, feeder-cattle prices are inversely related to corn prices, which are directly related to crude-oil prices. The point is, those markets are highly volatile, and some of that volatility filters back to the feeder-cattle market.”

Mark says “the opportunity to hedge feeder cattle for November, January or March (all at about $114 in late July) by selling futures is something to evaluate closely. These should generally provide a profit, too.”

Hedge or options?

Jessop isn't a fan of using options strategies. “I'm a true hedger,” he says. “In rare cases, I'll buy a low-cost put during really volatile price trends. But I'd rather lay off cattle with straight futures.”

Mintert says if producers are considering an options strategy, careful analysis must be used to measure the impact if prices move up or down. “Options premiums are expensive for a reason,” he says. “These are volatile markets. They reflect a tremendous amount of uncertainty.”

With a wide range of options strategies available, Mintert says a common spread strategy of buying put options to set a floor, and selling call options to reduce the cost of the protection, can provide solid risk management.

“However, producers should make sure to understand the marketing window,” he says. “The danger is having a floor price and ceiling price too close together. You could face margin calls if prices go up very far, which is what many try to avoid when using an options strategy.

“I encourage people to work through the strategy, to make sure they know what they're giving up when they sell a call.”

When considering a put-call spread, Mark agrees with Mintert. “With likely strong demand for feeder cattle this fall on top of a tight supply, I'd want to go a ways out of the money on the call, just in case we see a rally,” he says.

Mark notes that buying an out-of-the-money call to protect a short futures hedge is another strategy for those who feel the corn market might continue to drop and feeders will rally. “For example, a November $120 call could be purchased for about $2.40/cwt. (in late July),” he says.

“So the floor price could be established at about $111.50-$112 (before basis) with upside potential over the call strike price of $120. This is sometimes referred to as a synthetic put option.”

When Jessop is considering a hedging strategy, Jodie informs him of exactly how many pounds they have to deliver in the fall or the following spring.

Hedging isn't limited to yearlings. He also hedges cattle he feeds at Carrizo Feedyard in Texline, TX, of which he owns a small share. For example, he jumped on high futures prices in early summer.

“When live-cattle futures reached $116, I hedged cattle to be placed in the feedyard in late summer and fall to finish in the spring,” he says. “I felt corn would get cheaper; it backed off (by over $1.20/bu.) and I wound up with a reasonable cost of gain. That hedge should produce a pretty nice profit — for a change.”

Mark says producers and feeders should consider locking in grain prices, as well as distillers grain prices, again due to the volatility of all commodities and the threat of higher oil prices always out there.

Corn market is key

Mark says the fate of feeder prices, like fed prices, depends on the corn market.

“What's interesting is there are some profits to be had feeding cattle at different times, and there are feedyards expanding and adding bunk space despite collectively feeding the smallest calf crop in recent history,” he says. “So there's a valid argument for stronger feeder prices, too.”

Many trends in agriculture and the general economy lead Jessop to buy or sell cattle. He believes the demand for “cheap food” by Americans will convince the federal government to reduce its demand for grain-produced ethanol.

“I think the weakness of the U.S. dollar is going to help create more foreign demand for our beef,” he adds. “I also think we might see a softer domestic demand.”

But that doesn't keep him out of the market. It does, however, give him incentive to not only look for opportunities on the board, but to buy calves that have been on a preconditioning program.

“If it costs $5/cwt. more to buy a calf that's been weaned and preconditioned, it's nearly always worth it,” he says. “That's only $30 more for six-weight steers that have a lower death loss and produce a better gain on pasture or in the feedyard.”

Larry Stalcup is a freelance writer based in Amarillo, TX.

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