[fusion_builder_container hundred_percent=”no” hundred_percent_height=”no” hundred_percent_height_scroll=”no” hundred_percent_height_center_content=”yes” equal_height_columns=”no” menu_anchor=”” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” class=”” id=”” background_color=”” background_image=”” background_position=”center center” background_repeat=”no-repeat” fade=”no” background_parallax=”none” enable_mobile=”no” parallax_speed=”0.3″ video_mp4=”” video_webm=”” video_ogv=”” video_url=”” video_aspect_ratio=”16:9″ video_loop=”yes” video_mute=”yes” video_preview_image=”” border_size=”” border_color=”” border_style=”solid” margin_top=”-30″ margin_bottom=”” padding_top=”” padding_right=”” padding_bottom=”” padding_left=””][fusion_builder_row][fusion_builder_column type=”1_1″ layout=”1_1″ spacing=”” center_content=”no” link=”” target=”_self” min_height=”” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” class=”” id=”” background_color=”” background_image=”” background_position=”left top” background_repeat=”no-repeat” hover_type=”none” border_size=”0″ border_color=”” border_style=”solid” border_position=”all” padding_top=”” padding_right=”” padding_bottom=”” padding_left=”” dimension_margin=”” animation_type=”” animation_direction=”left” animation_speed=”0.3″ animation_offset=”” last=”no”][fusion_text]By Larry Stalcup, Contributing Editor
Feedyard and cow-calf profits are just a Corn Belt drought, an oil price rally or a major health scare away from turning into major losses if price protection strategies aren’t fully established.
Price volatility is the villain. It has turned cattle margins upside down more than once the past few years. From $170/cwt. markets down to barely $100 in a matter of months, and $200-plus per head profits to $200 losses in the same time period, rollercoaster price patterns have caused more than one case of incurable indigestion.
Marc Nemenoff has been a Chicago-based commodities broker/analyst for some 40 years. And as the senior account executive for The Price Futures Group, he can’t remember many times when price risk management has been so critical to sound marketing for cattle and other commodities.
“There has been a rise in volatility, which causes the need to lock in profits when one can,” Nemenoff says. “Cattle prices have seen a tremendous shift the last four decades. Live cattle prices have increased from 25 cents per pound 40 years ago to about $1.25 now. For every 10 percent move in prices, that amounts to a 12.5-cent move now to less than 2.5 cents back then. That 12.5 cents can make a large difference in whether you have profit or loss.”
In addition, input costs are higher and many outside factors can impact cattle prices. “There are so many more components involved,” Nemenoff explains. “The rise and flow of dollars, the impact of higher fuel and transportation costs and other inputs have become more cash-intensive the last 10 to 20 years.”
Volatility has caused even the best hedgers to experience big losses. Corn’s unpredictable price run-up during the 2012 drought and $140 or higher crude oil prices had some cattle feeders on the wrong side of hedges. It wasn’t pretty. Better understanding of futures and options strategies is helping novice hedgers and even longtime traders learn more about risk management.
Producers and feeders who may have been apprehensive about using futures or options in the past are now full or part-time hedgers, especially feedyard operators who often own well over 60-70 percent of the cattle in the pens. Their minds are more at ease with “those guys in Chicago.”
“People have learned that the futures industry is an honest game,” Nemenoff says. “People are using hedging more and more. Sometimes there’s pressure from banks and loan officers, who are somewhat demanding of having a hedging strategy in place to finance feeding opportunities. If one can show a banker how he can lock in a floor price on the board, the lender is more apt to finance the operation.”
An insurance policy
“One needs to think of hedging in terms of an insurance policy,” Nemenoff points out, repeating a phrase that’s been around a long time. “The upside of using futures or options to set a floor price is that it will help you stay in business. The downside is you may not receive the windfall profit should there be a black swan event when prices surge to the upside.”
The past few years have seen changes to the CME Feeder Cattle and Live Cattle contracts. They were designed to benefit potential users of futures and options. “The feeder contract went to a cash settlement price with more transparency in the actual price feeders are trading at in the cash market,” Nemenoff says. “In the live cattle market, the exchange has altered the contract several times in order to be consistent with industry standards.”
He notes that producers and feeders are broader in their use of futures and options. That applies to cow-calf operators who want to manage the risk of their calves, but don’t have a contract specific to their weights in the 500-pound range. “People have become inventive in using various contracts to hedge non-contract animals by altering the amount of contracts they’ll need to cover their different weights and grades,” Nemenoff says.
Options strategies can provide various types of price protection. But like insurance policies for a pickup, tractor, combine or barn, options premiums can be expensive. For example, for cattle placed on feed in late June to finish in November or December, the December 2017 Live Cattle futures were trading at about $113/cwt. A typical breakeven for a 1,300- to 1,400-lb. steer was about $112-$115. To buy a $113 put option would have cost roughly $6/cwt., or well over $60 per head.
However, in another strategy to prevent a major loss, an out-of-the-money $108 put would have cost about $4/cwt., still over $40 per head. A $105 put option would have cost about $3/cwt. or a little over $30 per head. All of these put strategies would cover a wreck, but leave the producer or feeder open to upside swings in prices.
With the amount of capital still topping $1,500 per head to finish a single steer, put strategies could save the farm, should markets take limit-down dives about the time a set of cattle is ready to sell. Nemenoff says there are ways producers and feeders can manage their risk and lower their cost of price coverage.
“One has to be a little inventive to keep from paying the $6/cwt. at-the-money price of a put option,” he says. “Hedgers can use put or call spreads, depending on their needs as opposed to using outright puts or calls.
“An example would be to sell $10 out-of-the-money calls and buy $2 out-of-the-money calls,” he explains. “The downside would be covered at a lower cost. However, such a strategy can be a little risky, given the odds of a tremendous break in prices. Everyone has a different plan. There’s no one set strategy that works for everyone.”
Learn the game and use
Nemenoff encourages potential hedgers to seek a commodities firm that offers experienced personnel. “There are many experienced brokers,” he says. “The average broker in Price Futures Group has been in business about 30 years. I’ve done this some 40 years. That fact that those in our company have survived so many years speaks volumes about their competency.
“When considering a hedging strategy, read up as much as you can on the use of futures and options,” he advices. “The CME Group, ICE and other commodity exchanges offer many publications that detail hedging in terms that are fully understandable. It’s not rocket science.
“The Price Group brokers are very professional and willing to somewhat mentor someone along and be able to discuss the pros and cons of an individual’s hedging strategy. We’re out to keep our customers for a long time. We won’t do a mis-service by suggesting a plan they are uncomfortable with, or that puts them at undo risk.”
Price Futures Group was founded in 1988 by Walter Thomas Price III. Known as Tom to many in the beef industry, he was a professional trader and agricultural hedger. He was originally from Amarillo, where he was a rancher and feedyard owner. The origins of the firm stem from hedging livestock and grains in the futures markets for a handful of cattle ranchers and farmers.
The firm now has branch offices around the country, and agriculture remains the core of its business today. For more on futures and options trading and other price risk management, visit its website at http://www.pricegroup.com. Marc Nemenoff can be reached at (312) 264-4310.[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]