Market Analyst Says Now Is the Time to Defend Sky-High Cattle Prices

What Happened

Stronger-than-expected demand and limited supply has helped rally cattle prices to new all-time high levels. Many believed that demand for beef would slow after the holidays, as consumers (potentially facing a lot of bills from the holidays, property taxes, and otherwise) would start looking for alternatives to high-priced beef products. That, however, doesn’t appear to be the case. Cattle prices continued to surge, evident this week with futures closing sharply higher for five consecutive sessions, reaching over $208 on the February contract. Surging product values suggest consumers are still willing to pay higher prices for beef.

Why This Is Important

High prices can offer an opportunity to shift risk and lock in value. This can be done in many ways. The most common used tools are forward contracting and selling futures (hedging). The advantage of forward contracting is: Once a contract is in place (identifying the price, delivery date, and location), the producer and buyer have shifted their risk. For the producer, the downside price risk is eliminated. For the buyer, the upside price risk is eliminated. 

In hedging, the producer does not lock in a cash price, delivery date, or location. Rather, a hedge is accomplished by selling a futures contract through a broker. If the contract price moves higher, the hedge account will show a negative balance, and the producer must add funds (margin call) to maintain the position. If prices move lower, the account will show a positive balance. The producer is subject to basis risk. That is, the cash price perhaps not keeping up with the futures price. The advantage of hedging is flexibility. A hedge does not need to be held until delivery.

Another method to shift risk is to purchase a put option. This is done through a commodity broker. The buyer of a put option pays a premium for the right to sell futures. Risk is fixed to the premium plus commission and fees. A put, in essence, establishes a price floor. If a cattle producer buys a $200 April put, he has purchased the right to sell April live cattle at $200, though he does not have the obligation – it’s his option. The advantage of using a put option is that it leaves cattle unpriced, meaning they can still benefit from a rally if cash prices move higher.

What Can You Do?

Communicate with your advisor on how and when to execute hedge positions. Cash, futures, and options tools can work hand-in-hand. Buying a put is no different than any other tool in a toolbox.The key is to know when to use the right tool for the right function at the right time. The current surge in cattle prices suggests now may be the right time to consider put purchases.

Find What Works for You

Work with a professional to find the strategy or strategies that are 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.