Risk Management Considerations for Cow-Calf Operations
This year has been anything but low key in west central South Dakota where my wife and I, along with our two children, operate our cow-calf, stocker-backgrounder and custom grazing enterprises. We are dry and hot, as are many parts of the country. Feed is short in supply and cattle are being destocked. This has created some volatility in our region, but we believe volatility creates opportunity.
We have been actively working to manage our input costs such as feed, fuel, etc. We are optimistic about the current cattle prices, and we believe the futures markets are giving us an opportunity to protect prices that have not been available for some time. I want to share one way we are managing risk regarding marketing our cattle.
In sharing this with you, I hope it will help you better understand some of the tools available to use in your risk management, as well as navigate through some of the figuring that goes along with determining costs and expected selling prices. As with everything, it is easier to prepare and manage through unforeseen events if you have a plan, and we believe having a risk management plan plays a very crucial role in the success of our business.
There are several different ways to manage price risk, including futures contracts, options, spreads and LRP insurance. In our business right now, we are looking to use options and option spreads. Our reasoning behind this is our growing optimism for cattle prices down the road. We want to have a floor price protected in case of an unforeseen event that rocks the cattle market, but we also want to be able to capture as much upside potential in our cattle sales as possible.
For the purposes of this article, I am going to use a scenario that we may utilize in our cow-calf enterprise if we were to sell our calves in November off the ranch or at the local sale barn but want to take some risk off the table right now.
Let’s run through an example of purchasing a put option to lock in a floor price on a load of 550-pound steer calves:
Today, July 23, November Feeder Cattle Futures on the Chicago Mercantile Exchange are trading at $164 per hundredweight.
For basis (Basis = Cash – Futures) I am going to use +$10 for a 550-pound steer. (This should be fairly conservative.) As with any estimate, I would encourage you to verify your local basis by asking local cattle buyers or sale barns or looking back on previous sale reports before you take these numbers to the bank.
A November Feeder Cattle $164 Put Option can be purchased for approximately $3,000+commission fees, which should run around $50 for each transaction. This number can vary between different brokerages.
Expected cash sale price: $164 + $10 = $174 per hundredweight
Gross revenue on a 550-pound steer calf at $174 per hundredweight: $957 per head
Total (est.) cost to purchase the $164 November Feeder Cattle Put (including fees): $3,050
Each Put Option covers 50,000 pounds of weight: 50,000 pounds ÷ 550 pound calf = 90 calves
Total cost per calf: $3,050 ÷ 90 calves = $33.88 per head
Net revenue before taking out cost of production: $957.00 – $33.88 = $923.11 per head
While $923 per head doesn’t seem like any big runaway, keep in mind that is the bottom dollar you will receive, and by utilizing put options our top side is open, so we can capture any higher price the day we sell vs. giving it up in margin calls with a futures contract.
I believe this is the simplest way to establish a floor sale price. There are other ways to go about this, and if you have any questions or comments or would like to work through a scenario but are not sure how to go about it, please feel free to contact me at (605) 280-7753 or email@example.com.
I appreciate the opportunity to share one of the strategies we are using and would love to hear from you about strategies you are using in your operation that have worked well for you. It is our belief that we are all neighbors in this business, and we are always glad to help someone or share ideas that might help someone else’s bottom line.
Remember, “Luck is where preparation meets opportunity.”
Written by: Wacey Kirkpatrick, Kirkpatrick Cattle Company, Midland, S.D.
Source: Nebraska Cattleman September 2021 Magazine