Are You Defending the Rebound in Cattle Prices?

What Happened

August live cattle futures peaked on June 9 at $220.05 per hundredweight (cwt). Prices then slid over $12, anticipating that demand would weaken after the Fourth of July. However, August futures rebounded, screeching into a new contract-high price, trading just under $221 per cwt as of this writing. The sharp rebound came on the heels of better-than-anticipated Fourth of July demand, a weaker dollar, and futures short covering. Cash prices continue to hold a premium to futures, a likely contributor to higher prices. Still, high prices and time of year might suggest the market is vulnerable to a price peak. This most recent price recovery may be an excellent opportunity for cattle producers to defend against lower prices.

Why This Is Important

Historically, demand wanes in midsummer as grilling season is considered mostly behind the market. Unless the weather is brutally hot, weight gain is good. The long-term uptrend in cattle prices remains intact, however, concerns that consumer dollars are being stretched might also suggest another reason the market is vulnerable to a price break. Feeder cattle prices have been high for an extended period, implying breakevens are high as well. The risk to those finishing cattle is real, maybe as high as ever. Now is not the time to get comfortable with high live cattle futures prices. 

What Can You Do?

Purchasing a put option can offer an opportunity to establish a futures price floor and leave your topside open for a price advance. Risk on a purchased put is subject to premium paid, plus commission and fees. Due to high futures prices, put options may currently feel expensive. Everything is relative, meaning higher futures require higher premiums. Keep in mind, put options provide not only a price floor, they also provide peace of mind. Nonetheless, don’t let premium cost keep you from good marketing. If you’re willing to take the risk of capping upward price potential, selling an out-of-the-money call option to collect premium may help lower the purchase cost of the put option. Buying a put option and selling a call is called a fence strategy, as you are “fencing in” a price range.  

If you decide to use a fence strategy, be prepared for margin calls. When a call is sold, the seller (writer) collects premium, and also provides the buyer with the right to be long futures. If futures rally and the call increases in value, the writer must maintain a certain level of dollars in their account, called maintenance margin. A short call position can be exercised by its owner (buyer) into a long futures position. When an exercise occurs, the writer is assigned a short futures position at the sold strike price. If you can live with the idea of being hedged (short futures) at a higher futures price (compared to when the fence was entered),discuss this strategy with your adviser.

Find What Works for You

Work with a professional to find the strategy or strategies best suited for your operation. Communication is important. Ask critical questions and garner a full comprehension of consequences and potential rewards before executing. The idea is to make good decisions for the operation rather than emotionally charged responses to market moves, which are always dynamic. 

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

Disclaimer: The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy, or discipline will guarantee success or profits. Any decisions you may make to buy, sell, or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of the National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.

About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.