Risk management for cattle producers

The most recent USDA Cattle on Feed report confirmed the cattle herd is continuing to shrink, and high beef prices will likely be with consumers for some time. 

Cattle in feedlots came in at 98% of a year ago. High input costs and, more importantly, persistent drought conditions in the western half of the United States are a one-two punch that cow calf and backgrounders have experienced. 

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Feedlot operators have had to scramble for cattle and corn supplies just to source enough feed for each batch of new cattle put in the yard. This has pushed cash corn prices to unseen positive basis levels. It is a challenging environment, for sure. 

Using marketing tools can help to manage risk. 

This perspective will explore some ways those in the cattle industry could manage risk.

Let’s start with feeders. If you are seeking supplies, it is not unusual to hear “they are just not out there.”

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In the end, this means paying up. 

Putting cattle in your lot is what you do. So, if paying up, how do you manage the risk? 

The basic premise is that you own something that has a futures market behind it. Essentially, this means you can shift risk. 

Some might choose to hedge their feeder supply by selling futures and, once they sell their feeders, lift the hedge. When hedged, a futures price is locked. Unless the hedge is removed (assuming no change in basis), your price is locked in. 

The pro is that your price is locked; the con is that your price is locked. 

Others might purchase put options that provide the right (not the obligation) to sell futures. Puts are attractive, as they leave the upside open for price appreciation while establishing a price floor. The cost of puts needs to be considered, as these expenses are effectively raising the price paid for feeders.

If you have not yet bought feeders and are intending to, you may want to guard against upside price risk. You could either buy futures or call options. 

Call options provide the right (not the obligation) to own futures at a fixed price level. Once actual feeder cattle are purchased, you would then lift the long (bought) futures or call position.

If you are feeding cattle through to slaughter weight, then you might consider two risk avenues: feed and final product. 

The most weighted variable to feed costs is weather. In most years, weather determines if a bumper crop is to be had or if supplies will be limited and potentially rationed. 

In years of tight supply, consider buying corn using the hand-to-mouth mentality. In small supply years where weather is a factor, just finding corn could be an issue. Once corn is booked, consider buying put options so that, if corn prices drop, you’ve positioned yourself for the put to gain value and effectively reduce the cost of your feed. 

In plentiful corn and feed supply years, or if it looks like corn supplies will grow, consider purchasing call options to provide you the right (not the obligation) to own corn futures. View the calls as safety values, should weather suddenly drive feed prices higher. 

Final product refers to the time cattle will be marketed. If you like a price, you could hedge (sell futures). If you prefer to leave upside price potential in place, then purchase puts on live cattle contracts.

Ultimately, you have many choices in managing risk. Spend time with your advisor and review your alternatives with knowledge of the risks and rewards. 

Just having the knowledge of what you can do is powerful. Execution and review are the next critical steps. The key may be good communication so that, when decisions are made, you have a good idea of what the outcomes may be. Upon review, you can take comfort knowing you likely made the best decisions you could at the time.

Editor's Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.