Live Cattle: A Second Chance?
What’s Happened….
The live cattle futures market experienced heavy selling pressure in early August, with many contracts dropping nearly $14.00 per hundredweight. Why? After notching strong gains earlier in the year, packer margins were pinched with high cash prices, suggesting they were losing more than $100 per head. Once packers backed away from the high-priced cattle, it didn’t take long for prices to tumble.
After finding a bottom in mid-September, cash and futures prices rallied back to nearly the same levels prior to tumbling; near $190. Packer margins are now again estimated in the red, potentially setting the stage for weaker prices in the weeks and months ahead.
Why this is Important….
Sticky inflation and a lack of new demand drivers could be a concern cattle producers should not take lightly. This, coupled with two-year low feed prices (creating more demand and increasing the cost of feeder cattle), is yet another risk to the bottom line.
The recovery in live prices provides an opportunity for producers to be defense-minded and shift risk, something that just a few weeks ago seemed unlikely. Taking action to protect gains, shift risk, or both is at hand. Hedges suddenly look attractive, as do put option purchases and fence strategies.
What can you do about it?
Consider a fence strategy. A fence is a strategy where you purchase a put to establish a price floor and, at the same time, you sell an out-of-the money call to collect premium. If the underlying futures contract on the last trading day is below the strike price of the sold call, the premium from the sold call is collected. In essence, the short call premium received reduces the premium paid for the bought put. If the futures price is above the sold strike price, you still collect the premium, and you are assigned a short hedge (sold futures) at the strike price. You stand to lose the premium paid for the long put. A fence is a strategy that fences in a range of prices through a price floor and price ceiling. Keep in mind, the only way the ceiling is enacted is if prices rally, which also means your unpriced cash cattle gain in value up to the sold call strike price.
Now that prices have rallied, this could be the best time for you to implement strategy. Visit with your advisor. They can help you decide where and how to enter hedges and which strike prices to consider. They can also help you decide if a fence strategy is appropriate for your risk tolerances.
Find out what works for you….
Knowledge is strength. Understand your strategies before entering a position so that you have a clear idea of what the outcome will look like regardless of where the market moves. Hedging (selling futures) and fences have an unlimited exposure to risk and may require margin call. To that end, it is also time to have a conversation with your lender if cash flow is needed to hold positions.
Work with a professional to find the strategy or strategies that are best suited for your operation. Communication is important. Ask critical questions and garner a full comprehension of consequences and potential rewards before executing. The idea is to make good decisions for the operation and less emotionally-charged responses to market moves, which are always dynamic.
About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.