It's a marketing tool that can help protect cattle feeders from $1 higher corn prices in what's become one of the most volatile periods ever for cattle and corn markets.
“We must be prepared for a lot of volatility in cattle and corn prices,” says Derrell Peel, Oklahoma State University Extension livestock marketing economist in Stillwater, and a proponent of the “Crush” strategy. “We're going to be all over the board for the next three to five years.”
The Crush involves using live-cattle futures or options, feeder-cattle futures or options, corn futures or options and various combinations of all three. But such a realm of Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) contract combinations to lock in a certain price for all three commodities can baffle even the savviest traders.
It's especially confusing for cattle feeders who don't use any kind of futures or options to protect prices, but depend on a steady cycle of feeding several pens a year to balance out. But with cash corn prices ranging from $3+/bu. in parts of the Corn Belt to $4+ in the Southern Plains, better market management may be needed to prevent a massive mistake.
A soybean-market tactic
The Crush term comes from soybeans, which are crushed to become meal and oil. Buying beans while selling meal and/or oil is the “Crush spread.” The cattle-feeding Crush involves selling, or being short, live cattle futures, and buying, or being long, feeder cattle and corn futures. You're buying the two components needed to produce and finish the slaughter-ready cattle that are sold.
When examining cattle and corn prices recently, the spread was a feasible tool for protecting cattle coming out of the feedyard this spring, Peel says. Using numbers on the CME and CBOT in early December, a small profit, or at least a breakeven, could be squeaked out with a Crush in place.
Peel figured in the purchase of about 100, 750-lb. heifers at a March 2007 futures price of $98/hundredweight (cwt.) The Crush also involved buying March corn at $3.90/bu. Figuring in a Southern Plains basis of +50¢, that put the feed price at $4.40. April live cattle futures were sold at $90/cwt.
If the cattle were fed a typical 160 days, the projected cost of gain was about 62¢/lb. The breakeven was $88 for the finished cattle. The $90 futures provided the cushion.
All that's on paper, of course, considering how winter weather can impact gain and overall performance. But the Crush numbers don't lie, considering the odds cattle in the yard could face questionable winter performance no matter what type of marketing plan is in place.
Variations of a Crush can replace the futures contracts with options, or protect the futures positions with options.
Buying a live-cattle put option to set a floor would accomplish the same goal as selling a live-cattle futures contract, minus the cost of the put premium. If live prices were down at slaughter time, protection would be in place. If prices increased, the upside would be open.
At the same time, the strategy could shift to buying call options on feeders and corn to accompany the futures. If either feeder or corn prices increased, the calls' increased value would offset losses from the futures contract.
As an example of using options in a Crush spread, a cattle feeder could buy an April $90 put for about $2/cwt., providing an $88 floor. A $98 March feeder-cattle call would cost about $2. A $3.90 corn call would cost about $6.
If either feeders or corn increase from those prices, the potential margin calls on the futures contracts would be offset by the increase in value of the call options.
Of course, with volatility in the market, corn prices could just as easily drop if: plans for the many projected ethanol plants don't come through, corn acres increase substantially or feeding numbers drop. The corn futures contract would cover that decrease.
In that case, having the ability to recover some of the expenditures on high-priced corn can be a plus.
“I feel we've topped out on corn prices,” Peel says. “We're on the edge of prices starting to go down.”
But the slightly downward shift in corn prices might reflect volatility more than the reality of higher corn prices for good, says Monte Winders, commodity broker/analyst for Financial Freedom & Futures, Amarillo, TX.
“I've seen several areas in which analysts are projecting a higher plane for corn prices,” he says, “similar to how finished cattle moved from the $60s and $70s to the $80s and $90s of today. Corn could now be entering a steady plane in the $3 to $3.50 range or higher.”
Winders says even if feeders don't use a full Crush strategy, they should consider using corn futures or options.
“They should at least look at buying March or May corn,” he says. “I think we'll see it turn back up again. I think we can see March in the $3.80 level, possibly closer to $4.”
Steve Amosson, Texas A&M University economist in Amarillo, says covering corn costs could be important.
“It never hurts to get some form of protection on corn,” he says. “Feed-grain prices often rise into the last part of January. Cattle feeders must utilize any lull. Maybe a call, spread or hedge. The volatile markets are scary.”
Amosson says shorter feeding periods will likely occur as feed-grain prices increase. Peel agrees protecting against higher feeding costs is often accomplished by placing heavier feeders and/or paying less for them.
“If corn goes up $1/bu., a 750-lb. animal must drop $7-$8/cwt. in price,” he says, adding that such a price shift happened in late fall. “You look at buying the 800-lb. animal and not buying the extra corn. But we're likely to see fewer 800-lb. calves for two years.”
Feedlot placements last October were down 13% from 2005, and 10% from 2004, USDA says. Net placements were 2.34 million head, the second-lowest October placements since 1996. Of those, 455,000 were over 800 lbs.; 485,000 were 700-799 lbs.; 645,000 were 600-699 lbs.; and 840,000 were less than 600 lbs.
Peel doesn't see the availability of heavier feeder cattle or placements increasing much for several reasons. Drought areas like Oklahoma, Texas and other states still need moisture.
“And if it rains much, we'll see the number of replacement heifers increase,” he says. “So I think we'll see tighter feeder supplies in '07, and it doesn't change much for '08.”
Bill Roser, manager of Wheeler Brothers Feedyard, Watonga, OK, isn't a Crush user, but he'll consider futures or options in certain situations. He depends more on efficient feeding and getting the most bang for the buck.
“You try to do as good a job of feeding as you can. You just need to recognize what grain costs do to gain costs and adjust through lower feeder-cattle costs or other measures. If you can put cheaper cost of gain early through a grazing program, take that approach. If you have access to byproducts, consider using more of them. All those come into play,” Roser says.
Peel says using a Crush strategy or other marketing plans using futures and options spread requires discipline.
“It's a complex strategy,” Peel says, “but we have a complex marketing situation.”
Larry Stalcup is a freelancer writer based in Amarillo, TX.