Cattle Futures are CTFC-regulated, exchange trade contracts on the Chicago Mercantile Exchange (CME). Futures contracts enable ranchers to lock in a price for their cattle with the promise to transfer ownership at a later date. This type of sale is referred to as a forward contract. The counter position would be to sell (short) a contract now and buy it back later. This is one way a cattle producer can use hedging to protect their profit margins.
talk to an agentBy technical definition, hedging is the use of commodities trading as a tool to lock in a profit margin. In the cattle industry, hedging is a tool that is most commonly used in feedlots.
Typically their hedging strategy operates in 3 steps. First, they’ll inspect the cattle. Then they’ll negotiate the price with the rancher. Finally, when they lock in the price, the feedlot company will then turn around and hedge those cattle as well to lock in their profit margin.
Feedlots aren’t the only sector of the cattle company that can utilize hedging to protect their profits. Ranchers can implement this tool too as part of their risk management strategy.
With an LRP policy through Redd Summit Advisors, ranchers are able to insure market prices for their fed and feeder cattle, and unborn calves that haven’t hit the ground yet. And, there is no minimum number of head required to receive coverage.
In addition to your LRP insurance policy, you’ll also have the support of industry experts, who closely monitor market conditions, and can let you know when it is the best time to enact your LRP policy and lock in a floor price for your endorsement period.
Cattle ranchers can hedge in two ways: sell a position for a similar date and similar class of cattle that they expect to sell, or purchase an option.
As an example of the first hedging tool, assume you’ve bought a group of feeder calves today at $165/cwt. You expect to sell them in four months. Then, you would turn around and go to your futures broker to sell a position that corresponds with the month you expect to sell those calves. Assuming your break even on those calves is $157/cwt you are locking in an $8 profit margin, regardless of any rises or falls in the cattle market.
The upside of this hedging scenario is that if the market declines, you still maintain your $8/cwt profit margin. On the other hand though, if the market price rises after you’ve locked in your $8/cwt profit margin, you’re not able to take advantage of the upswing.
Instead of simply locking in a margin with a futures contract, you can purchase an option. This would grant you the right to purchase a futures position at a specified strike price before the expiration date. However, there is a cost associated with the option, and if you opt not to utilize the option, the fee is not refunded.
In this scenario, you could purchase an option for a futures contract with the same parameters as the example above. Then, if the market dropped, you could exercise your option and retain your locked-in profit margin. Likewise, if the market price rose, you can choose not to exercise your option, pay the cost of the option, but still cash in on the higher market price.
While hedging can be a great risk management tool for many ranchers, it’s not a universal solution to market volatility. It’s important to remember that hedging involves its own risk factors as well, and may not be right for some operations. However, that doesn’t mean you can’t operate your ranch with a “hedging mentality”.
Finding ways to mitigate market risk to your operation is always a great idea, and one way to do that is with a Livestock Risk Protection Insurance Policy (LRP).
As a rancher, you can use an LRP insurance policy to hedge against declines in the cattle market and protect your profit margins without limiting your upside potential.
LRP insurance is a USDA-subsidized program that allows livestock producers to “lock in” a floor price for their cattle. If the market price drops below the producer’s floor price during their endorsement period, their LRP policy will trigger an indemnity payment on the difference.
Because of the USDA subsidy, the US Government will cover a portion of your LRP insurance premium. And if your indemnity payment satisfies your premium balance in full, any additional payment will go straight to you with nothing out of your pocket.
One of the first steps to utilizing your LRP policy is to choose a “floor price” for your livestock based on USDA Agricultural Market Service Expected Ending Price, which is updated almost daily.
Once chosen, your LRP policy covers your livestock up to that floor price. It will issue an indemnity payment if the market declines during your endorsement period, which can last anywhere from 13-52 weeks.
If the cattle market has declined during your endorsement period, you’ll receive an indemnity regardless of whether you sold or retained ownership of your stock. Likewise, if the market price rises above your floor price during your endorsement period, you’ll owe a premium on your policy 30 days after the end of your endorsement period even if you retain ownership of your stock.
Whether or not you sell your stock, and for what price, does not play into your LRP policy at all. LRP insurance is based solely on shifts in the cattle market as reported by the USDA Agricultural Market Service Expected Ending Price.
With an LRP insurance policy, your upside potential is unlimited. While you are covered if the market drops below your floor price, you can take full advantage when the market swings upwards. This means you can cash in by selling your stock, and still retain a profit once your premium balance is paid.
talk to an agentCattle futures are CTFC-regulated, exchange trade contracts on the Chicago Mercantile Exchange (CME) that enable ranchers to protect their profit margins from declines in the cattle market by selling their livestock on a contractual basis. This means that a producer can sell their livestock at today’s price for their anticipated weight, but physically transfer ownership months down the line.
With herd liquidation expected to slow down, beef production is expected to be lower in 2023 than the previous year. This is expected to result in higher calf prices.
You can find Live Cattle (LE) prices on the Nasdaq.
You can invest in cattle futures by creating an account with the futures exchange through your broker and depositing the correct margin. Then you can start trading cattle futures contracts.
Cattle prices fluctuate year to year, but February and March are traditionally the best times to sell calves.
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