Econ 337, Spring 2012 ECON 337: Agricultural Marketing Chad Hart Assistant Professor

Econ 337, Spring 2012 Livestock Price Risk Tools  Livestock Futures and Options  Livestock Revenue Insurance  Livestock Revenue Protection (LRP)  Livestock Gross Margin (LGM)   Factsheets  Premium calculator 

Econ 337, Spring 2012 Livestock Risk Protection (LRP)  Price risk insurance coverage for hogs, fed cattle, feeder cattle, and lamb  Insurance protects against low livestock prices  70% to 100% guarantees available for cattle and hogs, based on CME futures prices

Econ 337, Spring 2012 Livestock Risk Protection  Coverage is available for up to 26 weeks for hogs and 52 weeks for cattle  Works sort of like a put option  Premiums are subsidized, the government pays 13% of the premium

Econ 337, Spring 2012 Livestock Risk Protection  Guarantees available are posted at:  Posted after the CME closes each day until 9:00 am Central Time the next working day  Assures that guarantees reflect the most recent market movements

Econ 337, Spring 2012 LRP Example

Econ 337, Spring 2012 LRP vs. Futures/Options  Futures and options have fixed contract sizes  Hogs: 400 cwt. or about 150 head  Fed cattle: 400 cwt. or about 32 head  Feeder cattle: 500 cwt., head  LRP can be purchased for any number of head or weight

Econ 337, Spring 2012 LRP vs. Futures/Options  Futures hedge or options can be offset at any time before the contract expires  LRP can not be offset, once you buy the coverage, you’re locked in

Econ 337, Spring 2012 Livestock Gross Margin (LGM)  Insures a “margin” between revenue and cost of major inputs for cattle, hogs, and dairy  Protects against decreases in cattle/hog prices and/or increases in input costs  Hogs  Value of hog – corn and soybean meal costs  Cattle  Value of cattle – feeder cattle and corn costs  We’ll talk about dairy later in the semester

Econ 337, Spring 2012 Livestock Gross Margin  Cattle (coverage for up to a year out)  Calves  Yearlings  Hogs (coverage for up to 6 months out)  Farrow to finish  Finishing feeder pig  Finishing SEW pig

Econ 337, Spring 2012 LGM Guarantees for Hogs  Farrow to Finish  Gross margin per hog t = 2.6*0.74*Lean Hog Price t - 12 bu. * Corn Price t-3 - ( lb./2000 lb.) * SoyMeal Price t-3  Finishing  Gross margin per hog t = 2.6*0.74*Lean Hog Price t - 9 bu. * Corn Price t-2 -(82 lb./2000 lb.) * SoyMeal Price t-2  SEW  Gross margin per hog t = 2.6*0.74*Lean Hog Price t – 9.05 bu. * Corn Price t-2 -(91 lb./2000 lb.) * SoyMeal Price t-2

Econ 337, Spring 2012 LGM Guarantees for Cattle  Yearlings  Gross margin per head t = 12.5*Live Cattle Price t – 7.5*Feeder Cattle Price t bu. * Corn Price t-2  Calves  Gross margin per head t = 11.5*Live Cattle Price t – 5.5*Feeder Cattle Price t bu. * Corn Price t-4

Econ 337, Spring 2012 Livestock Gross Margin  Has deductibles, like car or home insurance  For cattle, deductibles from $0 to $150 per head by $10 increments  For hogs, deductibles from $0 to $20 per head by $2 increments

Econ 337, Spring 2012 LGM-Swine Farrow-to-Finish, Feb AprilMayJuneJulyAugust Gross Margin $78.74$93.20$91.74$91.59$90.59 Lean Hog Price $89.88$98.83$99.57$99.66$99.25 Corn Price$6.05$6.22$6.40$6.42$6.43 Soybean Meal Price $311.70$322.15$332.60$333.85$335.10

Econ 337, Spring 2012 LGM Example  Say we insure 100 hogs in April and choose a $2 deductible  Our LGM policy is protecting us against gross margins below $76.74 per head  When April comes, the insurance company will compute the actual margin using the same formula as was used for the guarantee

Econ 337, Spring 2012 LGM Example  If the lean hog price fell to $88 per cwt., the corn price fell $6.00 per bu., and the soybean meal price stayed at $ per ton, then the actual gross margin is  Actual gross margin per hog t = 2.6*0.74*$ bu. * $ ( lb./2000 lb.) * $ = $75.72 per head  Per head indemnity = $ $75.72 = $1.02

Econ 337, Spring 2012 LGM Issues  Only available on the last business Friday of the month  Is a complicated insurance policy  Works like an Asian basket option  Asian = uses a price average  Basket = covers more than one commodity  Like a put on cattle/hogs and calls on feeder cattle, corn, and soybean meal

Econ 337, Spring 2012 Who can benefit from LGM/LRP?  Producers who depend on the daily cash market or a formula related to it.  Producers with low cash reserves.  Smaller producers who do not have the volume to use futures contracts or put options.  Producers who prefer insurance to the futures market. No margin account.

Econ 337, Spring 2012 Some Risks Remain  LRP, LGM do not insure against production risks  Futures prices and cash index prices may differ from local cash prices (basis risk)  Selling weights and dates may differ from the guarantees

Econ 337, Spring 2012 Class web site: Spring2012/ Have a great weekend!