Time to defend cattle prices, analyst asks
Cattle prices this year have recovered from a sharp drop in price during 2020, when futures plunged from over $1.20 per pound to the mid $.80s in a matter of months.
Since a full recovery has occurred in futures, both in the nearby contracts as well as deferred contracts, they are currently offering risk-shifting opportunities. Producers should pay attention, as contracts have made a near nonstop continuous uptrend for 12 months. Improved demand prospects as COVID-19 numbers slid into the midsummer helped provide longer-term demand expectations. Still, growing concerns are beginning to mount regarding increased worldwide cases of the COVID-19 Delta strain.
When markets trend higher, they can do so in a very steady fashion. This has been the case for the cattle market. In some sense, it lulls producers into a mind-set that doing nothing has been the best strategy. In other words, watching has paid dividends as prices have improved. The problem with the do-nothing strategy is that, at some point, if prices either make a correction or change trend, it can happen quickly and without much warning. When a top is in place (and this is only known with the benefit of hindsight), the move lower may be so fast, you are unable to react to it. What was working well, doing nothing, suddenly is all wrong.
We offer three ways to defend cattle prices. In specific, we will use April live cattle futures for example purposes. April futures are currently trading near $1.40, climbing well over $.20 since late fall of 2021.
1. Forward Sell
If available, one method to shift risk is to forward sell. This locks in a price. You have a contract specifying delivery and grade of your cattle and, in turn, the buyer agrees to take delivery and pay the amount the contract specifies. The pro of this is you have a price locked. The con, of course, is you lose participation if prices rally.
2. Buy Call Options
A second method is an add-on to the first – where you forward sell and buy call options. Call options, when purchased, provide you the right to own cattle futures (in this case April), and not the obligation. If prices drop, your risk is subject to the cost of the call. If prices rally, you can benefit from the call if it gains value. Most options are offset, that is, you would sell your call once you move your cattle. Or the call could expire without value. Your net selling price for your cattle is the forward contract price, less the cost of the call option (plus commission and fees), plus the gain or loss of the call.
3. Buy Puts
A third method is to purchase a put option, which gives the buyer the right, not obligation, to sell April futures at a specified price level (strike price). Risk is subject to the cost of the option plus commission and fees. This method establishes a futures price floor for April live cattle. You leave your cattle unpriced until you deliver. With a put option strategy, your cash (actual) cattle are unpriced and, therefore, you can participate in a price rally.
As with any strategy, make sure you fully understand the risk and potential benefits. In the case of the cattle market, when looking out several months, there may be various opinions of how prices will move. By incorporating strategy, you prepare yourself for these market moves and, in essence, are managing the market volatility.
Think about this: There is a right marketing tool for the right time for the right risk tolerance. And it needs to fit you. Remember, as discussed above, doing nothing is still a strategy. That doesn’t mean it is wrong, though it could be the riskiest, as you either benefit greatly or potentially are exposed to the most risk. Strive for balance in your marketing, which is what methods two and three in our examples accomplish.
If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-334-9779, extension 300.
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.