FEEDER CATTLE PRICE RISK MANAGEMENT DR. CURT LACY EXTENSION ECONOMIST-LIVESTOCK UNIVERSITY OF GEORGIA

LET’S TALK ABOUT RISK It is NOT uncertainty! It is the negative outcome associated with an unforeseen event. Good risk managers Know the odds Don’t risk a lot to make a little. Don’t risk more than they can afford lose.

DEVELOPING A “GOOD” RISK MANAGEMENT PLAN 1.Identify your major risks 1.Price 2.Production 3.Legal 4.Financial 5.Labor 2.Determine what constitutes a “wreck” for you 3.Learn about the alternatives to minimize or manage this risk 4.Develop and implement a risk management plan

FEEDER CATTLE PRICE RISK MANAGEMENT

GA FEEDER CATTLE PRICES,

CATTLE PRICING ALTERNATIVES Delivery Pricing AuctionNegotiated Floor Pricing OptionsLRP/LGM Forward Pricing Futures Hedge Auction or Negotiate for Future Delivery

BASIC DECISIONS Do nothing Forward price Pre-sell through an auction Hedge Minimum price LRP Option

CATTLE PRICING ALTERNATIVES Delivery Pricing AuctionNegotiated

DELIVERY PRICING Two most common forms Auctions Negotiated/private treaty Easy No delivery obligation Highest possible price Lowest possible price Risk = high Reward = high

DELIVERY PRICING EXAMPLE

CATTLE PRICING ALTERNATIVES Delivery Pricing AuctionNegotiated Forward Pricing Futures Hedge Auction or Negotiate for Future Delivery

FORWARD PRICING Most common forms Auction with future delivery Futures hedge Negotiated forward contract Ability to set or at least know what price you will receive. Advantageous if market is declining Less than highest price if market goes up. Risk = moderate Reward = moderate

MINIMUM PRICING Most common Put options Livestock Risk Protection (LRP) Trade small but certain loss (premium) in exchange for protection from uncertain and larger loss (declining market). Ability to set floor price  good in declining market Ability to get higher price if market goes up.

FORWARD PRICING/HEDGING EXAMPLE

“PERFECT” HEDGE – DOWN MARKET DateCash FuturesBasis 27-Apr $ Sell $ $ (5.00) 3-Aug $ Buy $ $ (5.00) $ Futures Gain (Loss) $ Net Price $ $125

“PERFECT” HEDGE – UP MARKET

CATTLE PRICING ALTERNATIVES Delivery Pricing AuctionNegotiated Floor Pricing OptionsLRP/LGM Forward Pricing Futures Hedge Auction or Negotiate for Future Delivery

MINIMUM PRICING EXAMPLE

PUT OPTIONS: Put Option - gives the holder the right but not the obligation to SELL a futures contract at a set price before the option expires. (Insurance against falling prices).  If you will be selling the commodity use a Put Think of a put option as a price FLOOR

PUT OPTION EXAMPLE – MARKET DROPS DateCash Basis 27-Apr Buy $ $ (5.00) Option premium $ (3.88)

PUT OPTION EXAMPLE – MARKET DROPS

PUT OPTION EXAMPLE – MARKET RISES

USING LIVESTOCK RISK PROTECTION (LRP) INSURANCE TO SET A FLOOR PRICE SPECIAL THANKS TO DR. DARRELL MARK, UNIVERSITY OF NEBRASKA FOR THESE SLIDES

LRP IS PRICE RISK PROTECTION Establishes A Floor Selling Price For Livestock Pays Producers If A Regional/National Cash Price Index Falls Below A Set Price Does Not Guarantee A Cash Price Received Basis Risk Must Still Be Considered Covers Feeder Cattle, Fed Cattle, & Swine

INSURANCE AGENTS Available Through Crop Insurance Agent System Agent Locator Tool On USDA Website

COVERAGE AVAILABILITY Coverage Available About 5pm To 9am CST Available Sat Mornings Until 9am, But Not Sun, Mon, & Holidays Coverage Initiated With Specific Coverage Endorsement (SCE) No Limit On Number Of SCEs Producers Have Flexibility On The: Timing Of Purchase Time Length Of The SCE Number Of Head Covered

LIMITATIONS ON NUMBER OF HEAD INSURED Fed Cattle Feeder Cattle Per Specific Coverage Endorsement 2,0001,000 Per Crop Year July 1-June 30 4,0002,000

LRP COMPARED TO HEDGING OR OPTIONS Advantages No need to establish brokerage accounts Can insure animals on individual basis “Guaranteed” availability for price protection for far- off futures contracts May be less expensive for deferred months Disadvantages Paperwork can take a while Available only for animals in certain states Can’t “lock-in” a price Can’t exercise or “sell back” contract if market goes up May be more expensive for nearer months

LRP PRICES FOR 05/23/2011

MINIMUM PRICING EXAMPLE

FEEDER CATTLE PRICE RISK MANAGEMENT DR. CURT LACY EXTENSION ECONOMIST-LIVESTOCK UNIVERSITY OF GEORGIA