With the reopening of the Japanese market in mid-December, recent foot-and-mouth disease (FMD) discoveries in South America and continued cheap corn, Bart Thoreson wants to leave his upside open for stockers ready for marketing this spring.
Thus, feeder-cattle put options, not straight hedges, were his choice for securing a comfortable floor price on feeders he'll move in May. With the puts, he can still recoup higher prices if they occur. And with a cattle market that's seen feeder futures remain in the lofty $100-$115/cwt. range for well more than a year, the Gruver, TX, producer isn't sure prices will drop any time soon.
Thoreson and his wife, Alexa, run 1,800-2,300 stockers annually on their wheat/corn farm operation that also includes a 1,200-head grower yard. Cattle are bought at regional auction sales, usually at 300 lbs. Most are newly weaned Angus or English-cross calves.
“We start gathering calves in July and continue through Thanksgiving,” Thoreson says. “They go on irrigated wheat pasture through the winter and a grower ration of our corn silage. They're marketed as 8-9 weights in May.”
His marketing strategy often involves using forward contracts with regional feedyards and/or feeder cattle futures. Options sometimes play a part, as they do for stockers to be sold as feeders in May. That marketing strategy began in October, several months ahead the normal marketing period.
“We bought $104/cwt., March 2006 feeder-cattle put options to set a floor under our cattle,” Thoreson says, adding that the puts will likely be rolled into May when the opportunity arises. “In figuring our costs of the cattle and other expenses, that level of price protection was a solid one. And the puts enable us to be open to the upside in the event of a price rally.”
Feeders kept paying the price
Potential for a rally was looking almost slim to none late last summer (2005), when fed cattle were projected to lose $60-$80/head based on feeder-cattle prices hovering in the $110 range. The thinking was cattle feeders wouldn't keep paying those prices for replacement cattle.
“There just weren't any hedging strategies that would work in the summer,” says Derrell Peel, Oklahoma State University livestock marketing economist. He says that with the continued high price of calves, and feeder cattle futures just above $100, using early 2006 feeder-cattle futures would have locked in a $40+/head loss for stocker operators.
But in early fall, the fed market rallied several dollars. Speculation for a large corn crop (later forecast at nearly 11 billion bu.), along with anticipation of reopened beef trade with Japan, were cited as reasons for the upward move.
“We just weren't comfortable being locked into a contract or futures price,” Thoreson says. “That was part of our strategy the past two years, and it wasn't the thing to do. We wanted our topside open.”
He believes there could be additional market strengthening once Japan opens. Plus, the effects of the bird flu worldwide could impact the U.S. market, as could FMD problems in Brazil (the U.S. could capture part of Brazil's Russian market).
In his options program, Thoreson figured a $102 breakeven for 750-lb. steers. He bought the $104 puts for a $1.60/cwt.
“With the quality of cattle we usually graze, we can often put on an extra 100 lbs., get them to 850 to 900 lbs. and still sell for the same price as the 750-lb. animals,” he says. “That will mean additional revenue for those cattle.”
The deal looks sound
Peel says the cost of options have been notoriously high the past few years, so Thoreson's deal looks pretty sound. In late October, Peel noted opportunities for straight hedges had improved with the price increases ($110) range for January through May.
“There were better opportunities to hedge using the January contract,” Peel says. “Then those hedges could possibly be lifted and rolled into March or April options if you thought the market was going up. Cattle could also be hedged against the March contract, and accompanied by a call option to create a synthetic put (that had upside potential).”
Because of the steep prices for calves, Thoreson is set on protecting his risk.
“In 2004, we had about 2,000 head that averaged 363 lbs. and bought at $1.50/lb.,” Thoreson says. “I never thought I would pay that much, and we're paying that much or more this year. That risk has to be covered.”
Peel says there's still a threat for feeder prices to fall.
“Sooner or later, I expect prices to go down,” he says. “Feedlots will continue to need $90+ to break even. And current feeder cattle prices don't allow for that.”
Larry Stalcup is a freelance ag journalist based in Amarillo, TX.
Look at livestock risk protection
Even though there's often a need to protect price risk for stockers sold as feeders, or fed cattle sold to a packer, some cattlemen frown on using futures or options. The USDA Risk Management Agency Livestock Risk Protection (LRP) program is an alternative.
“LRP is especially good for the small operation,” says University of Nebraska-Lincoln economist Darrell Mark. From one head to 1,000 feeder cattle can be covered in a single LRP contract.
LRP is strictly price insurance. It's not designed to be a price capture tool, but is more useful in preventing potentially devastating losses if prices plunge, he says.
The LRP-insured coverage price is based on the cash market, not the futures price. It looks closer at the cash feeder index set by the Chicago Mercantile Exchange.
“There are possibilities of less basis risk when hedging with LRP, particularly for fed cattle,” Mark says.
There's no enrollment cost but the cost of price protection is similar to the cost of a put option. For example, a $105 insurance floor price might cost the producer $1/cwt. in premiums. No commodity brokers are used in the program. Producers work through their licensed crop insurance agent.
Along with Nebraska, LRP insurance is available in 19 states: Colorado, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nevada, North and South Dakota, Ohio, Oklahoma, Texas, Utah, West Virginia, Wisconsin and Wyoming.
Rules for the government-run program can sometimes change, so Mark encourages producers to consult with their insurance agents or visit www.lrp.unl.edu for more information.