Time to Fence Cattle Using Options
Cattle futures have experienced a strong bump in prices over the last two weeks, with October futures trading from under $106.00 per hundredweight to over $116.00, topping on August 4 at $116.35. Consolidation just under $116.00 and expectations that ample supplies will be available to meet consumer needs suggest that cattle prices are in a long-term downward trend and rallies should be sold. Increased competition between pork and poultry are also likely variables to keep rally potential in check.
However, the biggest variable that could keep cattle prices struggling in the weeks and months ahead is availability of cheaper feed and a long-term downtrend for feed prices. We are now four crop years removed from tight grain supplies due to the drought of 2012. A very ample buildup of corn and wheat supplies (both in the U.S. and worldwide) could prompt producers to go back into the cattle business, choosing to feed heifers and cows as an alternative to selling at discounted prices. This year’s Midwest weather has been mostly outstanding. High-yielding wheat crops, as well as expectations for a record-large corn crop, will keep feed availability at a historically high level, with corn carryout expected at a very large 2.2 billion bushels.
One strategy that can establish a price floor and yet leave the topside open is a fence strategy using options. The mechanics are purchasing a put and selling an out-of-the-money call. We like this strategy, as it leaves a window for prices to appreciate. The short call will either expire without value and cheapen the cost of the put that is purchased, or futures will rally high enough, in which case the short call option will be exercised. If the short call is exercised, you’ll be assigned a short futures at that strike price (a higher price level than currently exists). With October cattle trading just under $115.00, consider purchasing October $114.00 puts and selling $118.00 calls.
If you have questions or comments, or would like help in creating a balanced strategy for your operation, contact Bryan at Top Farmer Intelligence (800-TOP-FARM ext. 129).
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