Risk Protection For Cattle Producers

“Wait on a profit, not a home run.” This marketing philosophy usually makes money for Robert Whorton, even though he may miss the top of the feeder-cattle market by $5-$10/cwt

“Wait on a profit, not a home run.” This marketing philosophy usually makes money for Robert Whorton, even though he may miss the top of the feeder-cattle market by $5-$10/cwt. The Hollis, OK, stocker operator looks for a profit opportunity at the same time he buys cattle, and then looks for the best marketing tool to secure a floor price.

Markets for stocker cattle have been as volatile as markets for fed cattle and other commodities, with outside forces – like hedge-fund speculators, stock-market slumps and the devastating oil spill – playing nearly as big a part as supply and demand on prices.

“Current market conditions remain fragile and, as such, producers should consider some level of price protection,” says John Michael Riley, Mississippi State University (MSU) Extension economist.

“We’re in the most volatile time of year when corn prices will have a daily impact on feeder and stocker values,” adds Matt Diersen, South Dakota State University (SDSU) Extension economist, reflecting the need for prudent risk management for stocker and other cattle producers.

Whorton, 34, runs cattle and grows corn, barley and wheat when he’s not serving as a Stockman’s Bank loan officer in Gould. He normally buys 300- to 500-lb. steers year-round using wheat, barley and Bermuda grass as forage, and whatever risk-management tool looks best to fit the market and a set of cattle.

Most often, selling futures is used as a method of pricing cattle. Whorton also has had success with forward contracts and option strategies. He hasn’t used USDA Livestock Risk Protection (LRP) in the past, but is interested in learning more about it.

Early 2010 marketing saw him protect cattle to be sold as 7- to 8-weight feeders in August, September and October. Straight hedges were his choice for price protection.

“I started selling August futures at about $105 early in the year,” Whorton says. “I sold futures through the spring on the August, September and October contracts, evenly spread over the three months. I wound up with a $108 average on all cattle that will sell this fall.”

Greed wasn’t in his marketing plan – just profit. “I figured I had about an $85 breakeven for the cattle, which we bought at 300 lbs. for about $130/cwt.,” Whorton says.

“Most of the futures were locked in before the run-up in feeder-cattle prices (to over $116). I left some money on the table, but I had a profit goal in mind in the beginning. When the profit goal became possible to lock in, I began hedging.

“I don’t believe in trying to hit a home run,” he continues. “The amount of capital required to operate has become substantial in the past several years. A young guy like me has to use some type of price protection. A large, fast decline in the market can take you out of business.”

Whorton used feeder-cattle options for spring 2009 stockers. “In the spring, I used option spreads to market cattle for summer and fall delivery,” he says. “I used a fence strategy last year in case the market moved up. I was covered with a floor and had part of the upside open.”

He hasn’t used LRP in the past, but Whorton sees it as a possible tool for late 2010 and into next year. LRP operates with a premium similar to options, but options are based off futures contract specs. One contract has specs of 50,000 lbs., or 60-70 feeders in the 660- to 849-lb. range. It would cover 100 head of calves.

“LRP’s best advantage over options is the ability to price any number of head,” says SDSU’s Diersen. “The feeder-cattle options contract represents 50,000 lbs. Not everyone operates on a scale divisible by 100 or so head.”

He says a good LRP ending date and coverage level are not always available. “Then you can go back to a good commodity broker who can help you bid for coverage in the options market,” he says.

LRP is a service from USDA’s Risk Management Agency. It’s available to producers in 37 states and enables producers to insure against declining market prices.

Like with federal crop insurance, LRP is purchased from USDA-licensed insurance agents. Producers must submit a one-time application for LRP-Feeder Cattle coverage. After acceptance, specific coverage endorsements can be purchased for up to 1,000 head of feeder cattle that are expected to weigh up to 900 lbs. at the end of the insurance period.

The annual limit for LRP-Feeder Cattle is 2,000 head/producer/crop year (July 1 to June 30). All insured calves and cattle must be located in a state approved for LRP-Feeder Cattle at the time insurance is purchased, USDA says.

LRP coverage is available in weekly increments for 13, 17, 21, 26, 30, 34, 39, 43, 47 or 52 weeks. Producers may also choose from two weight ranges – under 600 lbs. and 600-900 lbs.

They may select coverage prices ranging from 70% to 100% of the expected ending value. If the actual ending value is below the coverage price, the producer will be paid an indemnity for the difference between the coverage price and actual ending value.

LRP insurance provides the flexibility of options, but often at a lower rate. “I looked at the difference in premiums of options for various contract months vs. LRP (in June); each LRP premium was roughly 5¢/lb. cheaper than the equivalent put option premium on a 600- to 900-lb. steer calf,” says MSU’s Riley.

“The tight supply situation we’ve been in for a while now implies that prices will move higher with spikes in demand – as we saw this spring. As an operator, I might hate to give up any upside potential; thus, LRP might be the most attractive tool.”

With feeder-cattle futures prices at $108 in June, a sample LRP calculation for 100 head of steers to be marketed at 850 lbs. indicates a coverage price of $98/cwt. would cost the producer about $1,100 or just under $1/head.

Meanwhile, a coverage price of $104 would cost about $2,038, or about $2/head. And, a coverage price of $108 would cost about $3,000, or about $3/head.

It gets down to the type of risk management needed for a particular producer; the higher the risk coverage, the higher the price premium. The added cost for price protection is one reason many stocker operators and other cattlemen don’t spend the money on LRP or options protection, Diersen says.

“Producers dislike spending money on something that may not pan out,” he says. “Insurance (LRP and options) will cost money today and may not give a benefit tomorrow. Finding some amount of insurance that provides a lot of protection is the key.

“Producers want to avoid being wrong big,” he says. “Locking in a price early can lead to regrets later. Spreading out sales mitigates that effect.”

Riley attributes some producers’ aversion to price protection to two primary reasons. “Producers consider the tools too expensive and many are uncertain of how the tools function,” he says.

Whorton says some producers sell cattle year-round without price protection. “They shoot for an average,” he says. “I try to run cattle all year, but try to wait for a good probability that the cattle price will allow me to secure a good profit, no matter which marketing tool I choose.

“I usually don’t hit the high in price – but you can’t go broke making a profit.”

Editor’s note: LRP-Feeder Cattle insurance is available in 37 states: Alabama, Arizona, Arkansas, California, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, Wisconsin and Wyoming.

Larry Stalcup is an Amarillo, TX-based freelance writer.

TAGS: Marketing