Fall has arrived and it brings the promise of fall crops hitting the bins, planters making the rounds, fall calving season in full swing, football rivalries heating up, deer hunters taking to the woods and the beautiful weather and color that accompanies this time of year. While we enjoy the pleasantries and vigors of the fall season, it is a good time to begin planning for next year’s operating cycles and evaluate the risks inherent to every operation. As those fall calves hit the ground, there is a good likelihood they will be worth more than ever before. With that said, it is important for producers to get the most out of those calves months down the road when it’s time to market. To ensure a profit in today’s volatile marketplace it is imperative to implement an effective marketing strategy coupled with a solid risk management plan. In order to accomplish just that, there are several tools available to livestock producers to help minimize market risk and take advantage of these record markets.
Livestock Risk Protection (LRP) is one of those tools which offer a variety of coverage levels and periods of insurance to correspond with marketing schedules. It provides price risk management to feeder and fed cattle producers as well as swine and lamb producers, however, we will focus on the feeder cattle aspect of the program.
This program is available from licensed insurance agents through the private crop insurance industry. LRP allows producers to protect against the risk of declining prices below an established coverage price. The coverage price is accomplished utilizing the CME Group Feeder Cattle Price Index weighted average prices for a specific marketing period to coincide with the producers marketing schedule. The basics of this program allows the producer coverage levels ranging from 70 percent to 100 percent of future market prices, can be purchased at any time in varying increments, provides coverage for up to 1,000 head per specific endorsement and up to 2,000 head per year all while being subsidized 13 percent. The cattle do not have to be sold at the end of the coverage period and if sold 30 days or more before the end date, coverage can be transferred to the new owner or forfeited in the event the markets trend positive during the coverage period. *
Another tool in the belt for livestock producers is to utilize Options to minimize the market risk. Put Options will be the focal point as we seek to protect the downside risk of the market.
A Put Option is an option contract in which the buyer has the right to sell a specified quantity of asset at a specified price, known as strike price, within a fixed period of time. In this case, that asset is feeder calves on area farms and ranches. The option contract trades in lots of 50,000 pounds of feeder cattle with prices established by the Chicago Mercantile Exchange, commonly referred to as the Board. This establishes a minimum price at a protection level that best suites the producer. A higher strike price will result in a larger premium cost and a longer time horizon will also result in higher premiums, thus creating many variables for cattlemen to consider and flexibility to match up price protection with marketing schedules.
A final tool to consider is a hedging strategy. A hedge is an investment made which establishes a price by selling a future contract. Establishing a future price helps protect the producer against a declining market and potential losses. When utilizing hedging, it is important to understand basis which is the difference between local cash price and the futures prices. The contracts are facilitated through a brokerage firm and typically require margin money be deposited with the firm to insure performance on the futures commitment. Fluctuation in market prices can result in additional funds being required to cover the margin calls. Margin calls maintain the hedge position and should not be viewed as losses but rather the cost of protecting against major price decline. Losses on the futures contract are offset by the increasing value of the cattle inventory and will be realized when the cattle are marketed and the hedge is lifted.
These are a few of the risk management tools available to help protect against market volatility, ensure your efforts are rewarded with positive returns and provide peace of mind through these challenging times. There are many factors to consider when selecting the proper risk management approach and these should be reviewed with your banker and other professionals providing guidance to your operation. It is important to keep in mind that each producer has different goals and objectives and the risk management tools selected need to properly align with the operation. Implementing a thorough marketing and risk management strategy will help properly position your operation to cash in on these record prices while protecting the downside of major market corrections. Keep your eye on the prize and enjoy the ride along the way.
* The Power of AgMax http://www.agmaxinsurance.com/crop-insurance/livestock-risk-protection.aspx, 2014 FBL Financial Group, Inc.
