TOP FARMER INTELLIGENCE – Weekly Perspective by Bryan Doherty
Live cattle futures have traded strongly higher since early September, reaching their highest levels in a year. February cattle bottomed just above $105.00 and have traded, as of this writing, to $124.87, near a $20.00 rally. The April contract has had a similar move, trading from $109.37 to $125.85. Rallies of this magnitude do not occur frequently. When they do, it is imperative to pay close attention.
The old saying is “the higher a market goes, the faster and harder it falls.” Could this be the case for the cattle market? As prices rally, there is every reason for the trend to continue. Cash cattle prices have moved higher, as fall weather for weight gain has been less than ideal, and demand has been strongly higher for choice cuts. Tighter world hog supplies are increasing expectations for strong exports. Add to that a potential smaller feedlot supply due to a weather “bomb cyclone” this spring limiting some supply, higher corn prices in June suggesting some herd liquidation, and you have a rally with a fundamental backing. At some point, however, despite strong fundamental and technical indicators, the market will make a turn. When it does, the drop in price can be violent.
To protect against lower prices, there are a couple of methods we would like to review. One method is to follow the market with a stop order. You place a stop order, or trigger point, underneath the current market price. This order is executed only if the market trades through this level. In an up-trending market, different criteria may be used to determine where your stop order is to be placed. As an example, you could use a moving average. April live cattle have not closed below the 10-day moving average since early September. As of this writing, the 10-day moving average is $124.00. This means you are not a seller until April cattle trade under $124.00. As futures move higher, you can adjust the stop higher.
A second strategy is to use put options. Put options are similar to insurance against lower futures prices. The buyer of a put has the right, not the obligation, to sell futures. You are at risk of losing the premium paid (cost of an option) if, at last trading day (expiration day), futures are above the strike price (level of protection). Yet, this risk is fixed, and your cash cattle can continue to benefit from higher prices. Should futures fall, the put option can be exercised into a short futures position, executing a hedge and shifting risk. This is usually only done at expiration (last trading day) if the put has value. Once exercised, you are subject to futures risk.
Often when markets move higher, there is a lot of intent or expectation to take action. However, sometimes prices peak and quickly fall, and you miss the opportunity. By using a stop order or put option, you have already established a strategy to shift risk and, therefore, are “in front of” the market. Without these positions in place, you are likely, on a daily basis, trying to outguess whether the market will close higher or lower. The key to good marketing is good preparation. Those who are prepared are in a much better position to execute.
If you have questions or comments, contact Top Farmer at 1-800-TOP-FARMER extension 129. Ask for Bryan Doherty.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.