Can We All Be Winners? we all be winners.pdf · Can We All Be Winners? Learning how to protect your price Jay Parsons [email protected] ... 1990 1992 1994 1996 1998 2000 2002 2004

Jay Parsons

Associate Professor, UNL

[email protected]

1

Can We All Be Winners?Learning how to protect your price

Jay Parsons

[email protected]

402-472-1911

Department of Agricultural Economics


What are

producers most

concerned about

when marketing

cattle?

Jay Parsons


[email protected]

2


What are

producers most

concerned about

when marketing

cattle?

1. Getting the

highest price

2. Covering costs

and making a

profit

3. Looking really

smart

C-P-06

02/05/20

50

75

100

125

150

175

200

225

250

275

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021

$ Per Cwt

AVERAGE ANNUAL CATTLE PRICESSouthern Plains

500-600lb Steer Calves 700-800lb Feeder Steers Fed Steers

Data Source: USDA-AMS, Compiled and Forecasts by LMIC

Livestock Marketing Information Center

Jay Parsons


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3

C-P-66

02/05/20

-100

0

100

200

300

400

500

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

$ Per Cow

ESTIMATED AVERAGE COW CALF RETURNSReturns Over Cash Cost (Includes Pasture Rent), Annual

Data Source: USDA & LMIC, Compiled by LMIC




C-P-67

02/05/20

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0

100

200

300

400

500

600

700

800

900

1000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

$ Per Cow

ESTIMATED AVERAGE COW CALF COSTSTotal Cash Cost Plus Pasture Rent, Annual


Livestock Marketing Information Center02/05/20

Jay Parsons


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5


Nebraska 2019 Cow-Calf Budgets

go.unl.edu/cow-calfbudgets



Unit Cost of Production

Jay Parsons


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(Cash Costs)

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(Adjusted Cash Costs)


What is a Marketing Plan?

Jay Parsons


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Marketing Plan Questions– What to produce/sell?

– Where to sell?

– When to price/sell?

– What are the objectives and goals

given current market conditions and

your financial situation?

– How can you best accomplish your

marketing goals & objectives?

Jay Parsons


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9


Cash Markets

• Cash markets are those markets where the

agricultural commodity is physically traded

• Cash markets are often referred to as “local”

markets or “spot” markets

• Examples

– Livestock Auction Barn

– Video auction sales

– Direct/On Farm sales to feedlots


Cash Forward Contracts

• Contract to deliver physical commodity in the

future to a buyer for an agreed upon price.

• Cash forward contracts are sometimes

referred to as “private treaty” contracts.

• Examples

– Written agreement to deliver to a buyer

– Video auction sales w/ future delivery

– Direct/On Farm sales to feedlots w/ future delivery

Jay Parsons


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10


Futures Markets

• Futures markets trade standardized

contracts that specify delivery of

commodities at some future date

• Rarely does the physical delivery

actually take place between buyers and

sellers of a particular contract

• Futures market prices together with a

“basis” value determine the cash price


Cash & Futures Market

Relationship

• Cash Price = Futures Price + Basis

• Basis = Cash Price – Futures Price

• Usually, Basis less than 0

Jay Parsons


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Factors Influencing Basis

• Supply and Demand

– Seasonality of livestock markets

• Auction Sales

– Quality of livestock

– Competitive nature of the auction

• Number of buyer and sellers present


Cash Price = Futures Price + Basis

• A futures contract can be used to “lock in” a futures

price

• An options contract can be used to “lock in” a floor or

ceiling for the futures price

• LRP insurance contracts can be used to “lock in” a

floor for the futures price

• Cash Forward Contract (i.e. video sale) can be used

to “lock in” the cash price

• Basis Contract (i.e. formula contract) can be used to

“lock in” the basis

Jay Parsons


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12


Cattle Futures Contracts

• Feeder Cattle

– 1 contract = 50,000 lbs.

– 700-849 lb. Medium Frame #1 steers

– Jan, Mar, Apr, May, Aug, Sep, Oct, Nov

– Last business day of the expiration month

• Live (Fed) Cattle

– 1 contract = 40,000 lbs.

– 55% Choice, 45% Select Steers

– Feb, Apr, Jun, Aug, Oct, Dec


Futures lingo ~

• Offset

– Canceling the current futures position

– Achieved by entering into an equal BUT

opposite contract

– Example:

• Sell four Oct feeder cattle contracts in April

• Offset by buying four Oct feeder cattle

contracts before Oct 30 (or it is automatically

cash settled on Oct 31).

Jay Parsons


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Futures Contract Example• Oct 2020 Feeder Cattle contract

– Sell one contract on Feb 7 @ $150.90/cwt

– Contract value $75,450

– Commission charged by broker for “round-turn” trade

– Margin account deposit $4,050 (will vary depending upon

broker)

• Maintenance margin $3,375 (set by CME to cover daily price

limit change)$4,050=$8.10/cwt.

$3,375=$6.75/cwt.


Futures Contract Example• Oct 2019 Feeder Cattle contract @ $150.90/cwt

• Price goes down to $144.30/cwt

– Buy one contract at $144.30 to offset position

– Make $6.60/cwt on the round-turn trade minus commission

– Likely receive lower price in local cash market

• Price goes up to $155.00/cwt

– Buy one contract at $155.00 to offset position

– Lose $4.10/cwt on the round-turn trade plus commission

– Likely receive higher price in local cash market

Jay Parsons


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14


Put Options

• Put Options

– The right, but not the obligation, to sell a particular

futures contract at a specified price at any time

during the life of the option

– Establishes a “price floor” in the future


Options Terminology

• Strike price

– The specified price at which the underlying futures

contract may be sold (put) is called the option’s

strike price.

• Premium

– The option’s premium is the price of the option

– 2 Components of a premium

• Intrinsic value is the value of an option if it were to expire

immediately

• Time value is the amount by which the premium exceeds

the option’s intrinsic value

Jay Parsons


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15


Options Contract Example

• Oct 2020 Feeder Cattle contract

– Trading on Feb 7 @ $150.90/cwt

– Put Option Contracts Available

• Strike Price = $150.00; Premium = $6.825



– Commission for purchase and “round-turn”

trade if exercised


Put Option Example

• Oct 2020 Feeder Cattle Contract @ $150/cwt.

– Paid $6.825/cwt. = $3,412.50 for put option

– Futures Contract Settles @ $144.30

• Option is worth $150 - $144.30 = $5.70

• Net Gain = $5.70 - $6.825 = -$1.125 – commission

• Likely receive lower price in cash market

– Futures Contract Settles @ $155.00

• Option is worthless

• Net loss = $6.825/cwt. = $3,412.50

• Likely receive higher price in cash market

Jay Parsons


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16


Basis Contract

• Sometimes called “Formula Pricing”

– Most commonly used with fed cattle.

– Establishes “basis” from the future contract for a

cash sale in the future.

– For example, an agreement to price $2 below

October feeder cattle futures contract on Oct. 15

Livestock Risk Protection

(LRP) Insurance

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Nebraska Federal Crop Insurance DataRevised March 2019


LRP Feeder Cattle

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Livestock Risk Protection (LRP)

Insurance for Cattle

• LRP insurance offers price protection for cattle producers.

• Available in all counties across all states for:

– Feeder Cattle Weight 1 (< 600 lbs.)

– Feeder Cattle Weight 2 (600-900 lbs.)

– Fed Cattle (> 900 lbs.)

• Operates like a (European) Put Option

– Offered for 13, 17, 21, 26, 30, 34, 39, 43, 47 or 52-week periods

• Producers remain subject to basis price risk


Livestock Insurance: LRP for Feeder Cattle

Actual and Expected End Value of Feeder Cattle

• Expected End Value

– This is the expected price at the end of an insurance period for each

specific type and weight of feeder cattle announced daily on the

RMA website

• Coverage Prices

– the prices that may be insured by the producer

• Coverage Levels

– range from 70 to 100% of the expected end value

• Actual End Value

– This is the value of the cash settled CME feeder cattle index on the

end date of the insurance period, adjusted by RMA for feeder cattle

type and weight

Jay Parsons


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Livestock Insurance: LRP for Feeder Cattle

Premium Subsidy Levels

• Subsidy Levels

• New and beginning producers qualify for an additional 10%

subsidy


LRP Coverage RatesSteers Weight 1, October 1 end date, 34 week policy (Feb 6, 2020)

Expected End Value: $165.54 per cwt.

Source: www.rma.usda.gov

Jay Parsons


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20


LRP Coverage DecisionSteers Weight 1, October 1 end date,

34 week policy (Feb 6, 2020)

Expected End Value: $165.54 per cwt.

Which coverage price

would you choose?1. $164.14

2. $161.94

3. $159.74

4. $157.54

5. $155.34

6. $153.14

7. $150.94

8. $148.74

9. $146.54

0. $144.34


Livestock Insurance: LRP for

Feeder Cattle Example

Contract Data Value

Number of Steers 50 head

Expected Weight 500 pounds

Current Date Feb. 6

Marketing Date Oct . 1

Insurance Period 34 weeks

Expected Ending Value $165.54

Coverage Price $164.14

Premium Cost per cwt. $6.92

Producer Premium $1,729

Jay Parsons


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21


Livestock Insurance: LRP for

Feeder Cattle Example

• Suppose the CME-reported actual ending value is

$165.93/cwt. Would you receive an indemnity?

– NO = $165.93 > $164.414 (coverage price)

– NET = ($1,729)

• Suppose the CME-reported actual ending value is

$133.83/cwt. Would you receive an indemnity?

– YES = $133.83 < $164.14 (coverage price)

– INDEMNITY = $30.31/cwt x 250 cwt = $7,577.50

– NET = $7,577.50 – 1,729 = $5,848.50 or $23.39/cwt.


Futures + Basis = Cash Price

• Additional Tools

– Futures Contract

• basis risk, margin call risk, broker cost

– Put Option

• basis risk, upside potential, broker + premium cost

– LRP Contract

• basis risk, upside potential, insurance cost

– Basis Contract

• futures risk

Cash Auction or

Spot MarketFull Risk

Private ContractLocks it all in

Jay Parsons


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22


Jay Parsons, Associate Professor


[email protected]

402-472-1911

Livestock Marketing Plan ___________________ __________ Name/Entity Year

Expected Livestock Marketing

Quantity Weight Description Date

1.

2.

3.

Marketing Plan 1:

Target Market(s):

Price Expectations

Estimated Cost of Production

Goals/Objectives

Low 1.

Expected 2.

High 3.

Strategies Deadlines Actions

1.

2.

Marketing Plan 2:

Target Market(s):

Price Expectations


Goals/Objectives

Low 1.

Expected 2.

High 3.


1.

2.

Marketing Plan 3:

Target Market(s):

Price Expectations


Goals/Objectives

Low 1.

Expected 2.

High 3.


1.

2.

Jim Bob 2020

Livestock Marketing Plan ___________________ __________ Name/Entity Year

Expected Livestock Marketing

Quantity Weight Description Date

1. 170 600 Weaned steer calves Oct 25

2. 103 550 Weaned heifer calves Oct 25

3.

Marketing Plan 1: Weaned steer calves

Target Market(s): Feedlots and backgrounders

Price Expectations


Goals/Objectives

Low 150 170 1. Less than 20% chance of receiving

average price below 170.

Expected 175 180 2. Maintain chance of receiving

average price of 180.

High 195 190 3. Leave open the opportunity to

retain 40 head to feed out.


1. Insure floor price on national market

Mar 31 Complete LRP insurance application

Apr 15 Analyze/decide on Oct (26 week) LRP policy purchase

Jun 20 Analyze/decide on Oct (13 week) LRP policy purchase

2. Contract cash sales to lock in delivery price on part of production to limit downside risk

Jun 30 Contact at least 2 potential buyers

Jul 10 Analyze potential cash sales contract

Jul 15 Decide yes/no on cash sales contract

Documents

Can We All Be Winners? we all be winners.pdf · Can We All Be Winners? Learning how to protect your price Jay Parsons [email protected] ... 1990 1992 1994 1996 1998 2000 2002 2004