Feeder or Fed Cattle Price Risk and Futures Market Calculator Aid∗

Cattleman interested in the weaned calf pricing strategy need not assume the risk of large market swings by accepting whatever the market offers on market day. There are flexible pricing instruments available to lock in a desired price prior to market day, if the desired price is known. Utilizing the budget templates, cattlemen may calculate a price that includes all production and marketing costs, as well as a price that includes a payment to management. Should that price become available, the decision-maker has the opportunity to take it, whether it is on the cash, futures or Ag options market. The fed and feeder cattle templates in this section compare the expected returns from the cash market, a futures hedged position, a buy put option, a sell call option and a combination strategy of buying a put and selling a call.

Input Data Decision date is the date the steers or heifers are weaned and marketed. Expected market date is the date the cattle are expected to complete this particular phase. Cost data for input can be taken from the templates (stocker and fed cattle) that calculate cost of production. Care has to be taken in review of costs to certify that marketing costs are included in the cost of gain. If not, they should be entered into this template in “marketing cost not in production cost” input data cell. Payweight sales weight can be taken from the production cost templates. The templates estimate costs and also estimate payweight. Or, if used separately, the users may enter their own estimates. Expected sales day basis may be estimates done by the user or other basis estimates available to the user. Texas Agricultural Extension Service has a continuous-update basis information and estimation service for subscribers. Today’s futures price is the current quote from the Chicago Mercantile Exchange’s feeder cattle or live cattle contract for a particular contract month. Sources of such quotes include newspapers and commodity brokers.

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Prepared by Ernest Davis, Extension Economist-Livestock Marketing, and James McGrann, Professor and Economist-Management, Department of Agricultural Economics, Texas A&M University, Revised 10/25/02.

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Outlook or forecast price on market day may be the user’s estimates or anyone else’s they choose to use. Interest rate on capital is the interest rate the user must pay for borrowed capital or the interest rate given up because he used his own capital. A percent cattle hedged is a decision by the user on what proportion of the cattle he desires to hedge. Because of the fixed contract size by the futures market, it is seldom that exactly 100 percent of the cattle can be hedged. Consequently, the program lists expected net returns from both the hedged and un-hedged portions of the production. Number of contracts purchased must be a whole number and be below the calculated number of contracts required. Number of contracts purchased must be a whole number and cannot exceed the number of contracts required. Total broker hedge commission is the negotiated fee between the hedger and the broker. In futures hedging, it is a “round-turn” fee, i.e., not collected until the hedge is lifted or canceled. Total hedge margin fee is the initial margin fee required when making the hedge. Interest is charged against that amount since that much must remain in the margin account. Additional margin calls may be made, but are not accounted for in this program since the timing would be uncertain and would make only pennies per hundredweight differences. Broker option fee is the negotiated fee between the option user and the broker. In options trading, there is a fee at each transaction, since option contracts may just expire with no value. Strike price is the options price selected from the commodity options market by the options user. Put or call premium is the fee or cost of a particular option contract strike price. The option buyer pays the premium fee and the option seller collects the premium.

Reports Calculated values for net returns are provided for with and without using the hedging option. The hedging net return is only for the portion hedged. It is important to recognize that the hedging option does provide a risk management strategy that is not possible without the hedge.

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Calculations Where the broker hedge commission per cwt. for a 50,000 pound feeder and 40,000 fed cattle contract is (broker hedge commission/500) for fed cattle. Broker option fee per cost is feeder contract (broker option fee/500) A.

Cash market (no protection) Expected net returns without hedge is (outlook or forecast price – (total cost of production + marketing costs not included in production costs))

B.

Cattle Hedge Expected net return from hedge is: (today’s future price – (total cost of production + marketing cost not included in production costs – Expected sales day basis + broker hedge commission + margin fee interest)) Total expected net return from hedge is: (Expected net return with hedge per head)*(Number of head*percent hedge*.01) Margin interest is (((((Expected futures price – today’s future price)*(number of contracts*500))/2) + initial margin deposit)*(.00274*days future contract held*interest rate*.01)/(number of contracts*cwt. per contract) Note: The .00274 constant converts an annual interest rate to a daily rate. Net return from cash sales is the same as section A – Cash sale or sales value per head times the umber sold. Net return from hedging activity is ((today’s future price – calculated futures price) – (broker hedge commission + total margin interest))*(number of contracts*500))

C.

Cattle Option Buy a Put Calculated futures price is (expected cash price – expected sales day basis) Calculated future profit Broker option fee is: If strike price is greater than calculated future price, the broker option fee is multiplied by two. If it is not, then it is the broker option fee.

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Calculated profit on futures: If the strike price is greater than the calculated future price, then its strike price calculates the future price. If not, it is zero. Net cost of trading puts is (put premium + broker option fee – calculated profit on futures. Net sales price Net sales price on contracted cattle is (forecast price + net cost of trading puts). Expected net return per cwt. is (sales price on contracted cattle – (cost of production + marketing cost not in production cost). Net return from hedging activity is: ((the net cost of trading puts) * (the number of contracts) * (500)).

D.

Cattle Option Sells a Call Calculated futures price is (forecast price – basis). Broker hedge commission is zero if the strike price is greater than the futures price. If not, it is the hedge commission. Loss on futures If the strike price is greater than the calculated futures price, then it is zero. If not, then it is the calculated futures price minus the strike price Net cost of trading calls is: (the hedging commission plus the option fee + the loss on futures – the call premium). Net sales price Net sales price is (the cash sales price + the cost of trading calls). Net return from hedging activity is ((the net cost of trading) + (the number of contracts) + (500)).

E.

Cattle Option Buy a Put and Sell a Call Net return from trading puts same as in section C, Cattle Option Buy a Put Net return from trading calls same as in section D, Cattle Option Sell a Call

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Total return – window or fence is: net returns from trading puts + net returns from trading calls Expected net price is: forecast price + total return from trading (window or fence). Calculated net premium is: (call premium – put premium). Net expected price: market down is (put strike price + expected sales day basis + calculated net premium – three * broker option fee). Net expected prices: market up is (call strike price + expected sales day basis + calculated net premium – two * broker option fee). Expected Net Return Expected net return from hedge is (expected net price – cost of production – marketing cost not in production costs). Net return from hedging activity is total return from trading (window or fence) times number of contracts times 500

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