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Marketing Tactics in Volatile Times
Matthew Diersen, Ph.D.Department of Economics
South Dakota State UniversityMay 6 & 8, 2008
2
Outline
General observations Volatility discussion Wheat strategies
Synthetic puts
Cattle strategies Timing price & risk
3
What Has Changed
Disruptions have occurred Question rural legends about marketing Ability to price like never before
Fundamental drivers Speculative forces
Need to deal with credible partners
4
Marketing Plans
One plan per enterprise Get a handle on the big picture High stakes mean:
more to keep track of more room for error
Evaluation more important than ever Understand what did not work
Contingency plans important
5
Pricing
Know what you are trying to “beat” Lock in “high enough” up-front profit Pull trigger after prices move favorably Reduce transaction costs Done with:
1. Handshakes to forward contracts
2. Futures contracts
6
Protection
Already realize profits Want to get higher returns Want to guard against wrecks Cover yourself prudently Done with:
1. Options contracts
2. Insurance contracts
7
8
Buying Options
A put option is the right, but not the obligation, to sell a futures contract
Cost is paid up front $/cwt quoted times the cwt of the contract
Premium made up of following parts Intrinsic value (strike-futures) Time value (interest) Volatility in futures price (biggest driver today)
A call option is the right, but not the obligation, to buy a futures contract
9
Money Talk
In-the-money put Strike price is above the futures price Implies a positive intrinsic value Will cost the most
At-the-money put Strike price is near the futures price May be closest-to the futures price
Out-of-the-money put Strike price is below the futures price
10
Price and Volatility Patterns for November 2005 Feeder Cattle Contracts
88
96
104
112
120
3/1 3/15 4/1 4/15 5/1 5/15
Sources: CME & SDSU
Set
tlem
ent
Pri
ce
($/c
wt.
)
4%
8%
12%
16%
20%
Imp
lied
Vo
lati
lity
Futures Volatility
11
March 2004 Feeder Cattle Price Behavior
75
80
85
90
95
100
Aug Sep Oct Nov Dec Jan Feb Mar
Mid-month Observations
Pri
ce (
$/cw
t.)
0%
5%
10%
15%
20%
25%
Imp
lied
Vo
lati
lity
Futures Price Floor Price Volatility
12
Daily Close of Nearby Spring Wheat Contracts
0
400
800
1200
1600
2000
1/2 1/16 1/30 2/13 2/27 3/12 3/26 4/9
Source: MT.gov
ce
nts
pe
r b
us
he
l
Kansas City Minneapolis
13
Historical Volatility by Month in CBOT
0
5
10
15
20
25
30
J F M A M J J A S O N D
Source: CBOT
%
Wheat Corn
14
Wheat Tactics
15
WHEAT: World Ending Stocks (millon bushels)
0
2,000
4,000
6,000
8,000
10,000
1987 1992 1997 2002 2007-08
Source: USDA - Economic Research Service & Foreign Ag ServiceSDSU Economics Department - http://econ.sdstate.edu
16
Wheat Tactics for Today
Winter wheat Know your insurance Cover sales by buying calls Buy put options
Spring wheat Forward contract prudent % Buy put options Sell futures & buy OTM calls
17
2007 Wheat Coverage in Montana
0
300,000
600,000
900,000
1,200,000
1,500,000
50 55 60 65 70 75 80 85
Percent Coverage
Ac
res
MPCI CRC RA
18
Crop Insurance
Often buy Crop Revenue Coverage (CRC) Futures have exceeded upper limit Hedge losses could greatly exceed indemnity Can be managed with call options
Risk Calculator Available at http://econ.sdstate.edu/ What level can be prudently hedged?
19
Pricing and Protecting Wheat
Rely heavily on KC, MPLS markets Better hedging performance
Work with lender on margin account Margin costs are higher
Worst-case returns likely low given: Low loan rate Increased production costs Inadequate insurance
Prices have some support from corn (feed)
20
Basis Risk & Storage
Highlights local conditions Transportation concerns Price convergence still probable
Crop insurance of no help Weigh basis improvement against carry
Tough to store with inverted markets Monitor interest opportunity cost
Some research supports some “speculative” storage behavior
21
Cover by Buying Calls
Before: forward contracted winter wheat for $9.00
Now: buy KC Sep $9.00 call for $0.75
Contract 9.00- Premium - 0.75+/- Basis n/a= Floor 8.25
* No ceiling *
Now: sell MPLS wheat futures for $9.00
Now: buy MPLS Sep $11.00 call for $0.40
Futures 9.00- Premium - 0.40+/- Basis - 0.80= Floor 7.80
* No ceiling *
22
Current Prices
23
Feeder Cattle Tactics
24
CHANGE IN BEEF COW NUMBERSJANUARY 1, 2007 TO JANUARY 1, 2008
(1000 Head)
2 to 141 (13)1 to 2 (3)
-6 to 1 (13)-25 to -6 (11)-74 to -25 (10)
Alaska
Hawaii
US Total
C-N-2802/01/08
-40-1
-10 22
-455
CT -1
DE 0
-14
-32
-3
-13
0 0-55
11 -48
23
1
MD -6
MA 2
-2
-8
1
-66
141
-57-15
1
NJ 1
20
-8
-20
-17
-4
30
8RI -0
-6
-25
-74
-63
21
0
-18
7
-10
5
-30
-339
Livestock Marketing Information Center
Data Source: USDA/NASS
53
25
Feeder Cattle Tactics for Today
Sell futures or forward contract Know the relevant basis
Buy put options Buy Livestock Risk Protection Build wide fences
26
Feeder Cattle Contracts
Contract is for 50,000 pounds of steers Contract months: January, March, April, May,
August, September, October, and November Futures settle on the last Thursday of the contract
month (except November) Cash settled to the CME Feeder Cattle Index
650-849 lbs Medium and Large #1, #1-2
27
Feeder Cattle Futures and Projections
90
95
100
105
110
115
A M J J A S O N D J F M
Sources: CME & USDA-ERS, April 17, 2008
$/cw
t.
Projection Range Futures Price
28
November Feeder Cattle Futures Change from March to Expiration
-20
-15
-10
-5
0
5
10
15
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
$/cw
t
29
Average Monthly Basis 5 - 6 Cwt Steers, BillingsPlus and Minus 2 Standard Deviations
-$5
$0
$5
$10
$15
$20
$25
$30
$35
$40
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Bas
is
Average Basis (00-07) Plus 2 STD (00-07) Minus 2 STD (00-07)
30
MED. & LRG. #1 STEER CALF PRICES500-600 Pounds, Billings, Weekly
75
90
105
120
135
150$ Per Cwt.
2004 2005 2006 2007 2008
Livestock Marketing Information Center 04/21/08
31
MED. & LRG. #1 STEER CALF PRICES500-600 Pounds, Billings, Weekly
75
90
105
120
135
150$ Per Cwt.
2004 2005 2006 2007 2008
Livestock Marketing Information Center 04/21/08
Seasonal Price
Increase
High Corn Volatility
32
Buy a Put
Oct Feeder Cattle trade at $110:
Out At In
Strike 104 110 114
- Premium - 3 - 5 - 9
+/- Basis + 8 + 10 +12
= Floor 109 115 117
33
Current Prices
34
LRP vs. Other Tools
LRP has Price Adjustment Factors Fixed percent up front and at settlement For Steer calves: 110%
Forward contracts likely give the best basis Synthetic put strategies need broker’s help LPR designed for spot sales in final 30 days
of coverage (transferable on earlier sales)
35
Typical Marketing Plan
Cow-calf producer with 140 steers & 100 heifers to sell on October 15, 2008
Buy 2 Oct puts (200 head), 108 strike, for $3.00 per cwt. or better
Buy LRP on 40 steers if floor exceeds $115 and cost is $4.00 per cwt. or better
Sell 1 Oct futures (100 head) if $115 or better (assume $10 cwt. basis)
36
For More Information
Commodity Exchanges CME, MGEX, KCBOT
USDA’s Risk Management Agency http://www.rma.usda.gov/
SDSU Department of Economics http://econ.sdstate.edu/ Extension / Current Market Analysis FS 929 – Writing a Commodity Marketing Plan ExEx 5055 – How to Capture High Calf Prices
37
Some Thoughts
“Put all your eggs in one basket, then watch that basket.” – Mark Twain
Active risk management means doing things 1) when prices are high, 2) when volatility is low, and 3) before its too late
Any Questions?