ECON 337 Agricultural Marketing Lee Schulz Assistant Professor

ECON 337: Agricultural Marketing Lee Schulz Assistant Professor lschulz@iastate. edu 515 -294 -3356 Chad Hart Associate Professor chart@iastate. edu 515 -294 -9911

Choosing from livestock risk management tactics

Livestock Price Risk Tools Ø Livestock Futures and Options Ø Livestock Revenue Insurance ØLivestock Revenue Protection (LRP) ØLivestock Gross Margin (LGM) Ø http: //www. rma. usda. gov/livestock/ ØFactsheets ØPremium calculator Ø http: //www. extension. iastate. edu/agdm/ldcostsreturns. html

Livestock Risk Protection (LRP) Ø Price risk insurance coverage for hogs, fed cattle, feeder cattle, and lamb Ø Insurance protects against low livestock prices Ø 70% to 100% guarantees available for cattle and hogs, based on CME futures prices

Livestock Risk Protection Ø Coverage is available for up to 26 weeks for hogs and 52 weeks for cattle Ø Works sort of like a put option Ø Premiums are subsidized, the government pays 13% of the premium

Buy LRP insurance policy… • Characteristics – locks in a “floor” price (CME cash index) – subject to basis risk – contract specifications somewhat flexible (e. g. , weight) – contract size flexible (FC: 1 hd up to 1, 000 – max of 2, 000 hd/yr) (LC: 1 hd up to 2, 000 – max of 4, 000 hd/yr) – – – – deal with crop insurance agent pay premium for LRP policy have to buy in “off hours” (i. e. , ~4: 00 pm – 9: 00 am) tied to options market (determines availability) price quotes available on RMA website (70% - 100% coverage) no risk of other party “backing out” no risk of low quality cattle being “refused” cash settled contract (no delivery ability / obligation)

Comparison of Livestock Risk Protection Policies… http: //www. extension. iastate. edu/agdm/livestock/pdf/b 1 -50. pdf

LRP Example… Coverage Length 13 weeks 17 weeks Expected Price $143. 30 $145. 04 Coverage Price $135. 47 $125. 47 $134. 44 $128. 44 Coverage Level % 94. 54% 87. 56% 92. 69% 88. 56% Cost per cwt $0. 670 $0. 095 $0. 527 $0. 171 *Other coverage lengths and prices available. Projected sales are for 100 head marketed in 17 weeks at a live weight of 1, 250 cwt, with 100% ownership. A 92. 69% guarantee is chosen. Premiums are subsidized, the government pays 13% of the premium. Insured value = 100 head x $134. 44 x 12. 50 cwt = $168, 050 Premium = 100 head x $0. 527 x 12. 50 cwt x 87% = $573 The final price at the end of the 7 week period is $134 per cwt. Actual revenue = 100 head x $134 x 12. 50 cwt = $162, 500 Indemnity payment = $168, 050 - $162, 500 = $5, 550 http: //www 3. rma. usda. gov/apps/livestock_re ports/main. aspx

LRP vs. Futures/Options Ø Futures and options have fixed contract sizes ØHogs: 400 cwt. or about 150 head ØFed cattle: 400 cwt. or about 32 head ØFeeder cattle: 500 cwt. , 60 -100 head Ø LRP can be purchased for any number of head or weight

LRP vs. Futures/Options Ø Futures hedge or options can be offset at any time before the contract expires Ø LRP can not be offset, once you buy the coverage, you’re locked in

Livestock Gross Margin (LGM) Ø Insures a “margin” between revenue and cost of major inputs for cattle, hogs, and dairy Ø Protects against decreases in cattle/hog prices and/or increases in input costs Ø Hogs Ø Value of hog – corn and soybean meal costs Ø Cattle Ø Value of cattle – feeder cattle and corn costs Ø There is a version for dairy as well

Livestock Gross Margin Ø Cattle (coverage for up to a year out) ØCalves ØYearlings Ø Hogs (coverage for up to 6 months out) ØFarrow to finish ØFinishing feeder pig ØFinishing SEW pig

LGM Guarantees for Hogs Ø Farrow to Finish Ø Gross margin per hogt = 2. 6*0. 74*Lean Hog Pricet - 12 bu. * Corn Pricet-3 - (138. 55 lb. /2000 lb. ) * Soy. Meal Pricet-3 Ø Finishing Ø Gross margin per hogt = 2. 6*0. 74*Lean Hog Pricet - 9 bu. * Corn Pricet-2 - (82 lb. /2000 lb. ) * Soy. Meal Pricet-2 Ø SEW Ø Gross margin per hogt = 2. 6*0. 74*Lean Hog Pricet – 9. 05 bu. * Corn Pricet-2 - (91 lb. /2000 lb. ) * Soy. Meal Pricet-2

LGM Guarantees for Cattle Ø Yearlings Ø Gross margin per headt = 12. 5*Live Cattle Pricet – 7. 5*Feeder Cattle Pricet-5 - 50 bu. * Corn Pricet-2 Ø Calves Ø Gross margin per headt = 11. 5*Live Cattle Pricet – 5. 5*Feeder Cattle Pricet-8 - 52 bu. * Corn Pricet-4

Livestock Gross Margin Ø Has deductibles, like car or home insurance Ø For cattle, deductibles from $0 to $150 per head by $10 increments Ø For hogs, deductibles from $0 to $20 per head by $2 increments

LGM yearlings example… Dec Jan Feb Mar Apr Gross Margin $118. 69 $89. 77 $81. 07 $104. 61 $164. 11 Live Cattle Price $146. 32 $147. 07 $146. 27 $148. 43 $150. 88 Feeder Cattle Price $199. 48 $202. 41 $203. 54 $204. 91 $200. 78 Corn Price $4. 28 $4. 61 $4. 42 $4. 28 $4. 32

LGM yearlings example… • Say we insure 100 cattle in April and choose a $20 deductible. • Our LGM policy is protecting us against gross margins below $144. 11 per head • When April comes, the insurance company will compute the actual margin using the same formula as was used for the guarantee

LGM yearlings example… • If the live cattle price fell to $146. 00 per cwt. , the corn price increased to $4. 80 per bu. , and the feeder cattle price stayed at $200. 78 per cwt, then the actual gross margin is: • Actual gross margin per fed cattlet = • (12. 5 * $146. 00) – (7. 5 * $200. 78) – (50 * $4. 80) = $79. 12 per head • Per head indemnity = $144. 11 – $79. 12 = $64. 99

LGM Issues Ø Only available on the last business Friday of the month Ø Is a complicated insurance policy Ø Works like an Asian basket option ØAsian = uses a price average ØBasket = covers more than one commodity ØLike a put on cattle/hogs and calls on feeder cattle, corn, and soybean meal

Who can benefit from LGM/LRP? Ø Producers who depend on the daily cash market or a formula related to it. Ø Producers with low cash reserves. Ø Smaller producers who do not have the volume to use futures contracts or put options. Ø Producers who prefer insurance to the futures market. No margin account.

Some Risks Remain Ø LRP, LGM do not insure against production risks Ø Futures prices and cash index prices may differ from local cash prices (basis risk) Ø Selling weights and dates may differ from the guarantees

Class web site: http: //www. econ. iastate. edu/~chart/Classes/econ 337/ Spring 2015/