ECON 337:

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ECON 337 Agricultural Marketing

Chad Hart Associate Professor chart_at_iastate.edu 51
5-294-9911
Lee Schulz Assistant Professor lschulz_at_iastate.edu
515-294-3356
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Choosing from livestock risk management tactics
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Livestock Price Risk Tools

• Livestock Futures and Options
• Livestock Revenue Insurance
• Livestock Revenue Protection (LRP)
• Livestock Gross Margin (LGM)
• http//www.rma.usda.gov/livestock/
• Factsheets
• Premium calculator
• http//www.extension.iastate.edu/agdm/ldcostsretur
  ns.html

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Livestock Risk Protection (LRP)

• Price risk insurance coverage for hogs, fed
  cattle, feeder cattle, and lamb
• Insurance protects against low livestock prices
• 70 to 100 guarantees available for cattle and
  hogs, based on CME futures prices

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Livestock Risk Protection

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

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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., 400 pm 900
  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)

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Comparison of Livestock Risk Protection Policies
http//www.extension.iastate.edu/agdm/livestock/pd
f/b1-50.pdf
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LRP Example
Coverage Expected Coverage Coverage Cost per
Length Price Price Level cwt
13 weeks 143.30 135.47 94.54 0.670
13 weeks 143.30 125.47 87.56 0.095
17 weeks 145.04 134.44 92.69 0.527
17 weeks 145.04 128.44 88.56 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//www3.rma.usda.gov/apps/livestock_reports/ma
in.aspx
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LRP vs. Futures/Options

• Futures and options have fixed contract sizes
• Hogs 400 cwt. or about 150 head
• Fed cattle 400 cwt. or about 32 head
• Feeder cattle 500 cwt., 60-100 head
• LRP can be purchased for any number of head or
  weight

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LRP vs. Futures/Options

• Futures hedge or options can be offset at any
  time before the contract expires
• LRP can not be offset, once you buy the coverage,
  youre locked in

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Livestock Gross Margin (LGM)

• Insures a margin between revenue and cost of
  major inputs for cattle, hogs, and dairy
• Protects against decreases in cattle/hog prices
  and/or increases in input costs
• Hogs
• Value of hog corn and soybean meal costs
• Cattle
• Value of cattle feeder cattle and corn costs
• There is a version for dairy as well

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Livestock Gross Margin

• Cattle (coverage for up to a year out)
• Calves
• Yearlings
• Hogs (coverage for up to 6 months out)
• Farrow to finish
• Finishing feeder pig
• Finishing SEW pig

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LGM Guarantees for Hogs

• Farrow to Finish
• Gross margin per hogt
• 2.60.74Lean Hog Pricet - 12 bu. Corn Pricet-3
• - (138.55 lb./2000 lb.) SoyMeal Pricet-3
• Finishing
• Gross margin per hogt
• 2.60.74Lean Hog Pricet - 9 bu. Corn Pricet-2
• (82 lb./2000 lb.) SoyMeal Pricet-2
• SEW
• Gross margin per hogt
• 2.60.74Lean Hog Pricet 9.05 bu. Corn
  Pricet-2
• (91 lb./2000 lb.) SoyMeal Pricet-2

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LGM Guarantees for Cattle

• Yearlings
• Gross margin per headt
• 12.5Live Cattle Pricet 7.5Feeder Cattle
  Pricet-5
• - 50 bu. Corn Pricet-2
• Calves
• Gross margin per headt
• 11.5Live Cattle Pricet 5.5Feeder Cattle
  Pricet-8
• - 52 bu. Corn Pricet-4

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Livestock Gross Margin

• Has deductibles, like car or home insurance
• For cattle, deductibles from 0 to 150 per head
  by 10 increments
• For hogs, deductibles from 0 to 20 per head by
  2 increments

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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
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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

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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

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LGM Issues

• Only available on the last business Friday of the
  month
• Is a complicated insurance policy
• Works like an Asian basket option
• Asian uses a price average
• Basket covers more than one commodity
• Like a put on cattle/hogs and calls on feeder
  cattle, corn, and soybean meal

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Who can benefit from LGM/LRP?

• Producers who depend on the daily cash market or
  a formula related to it.
• Producers with low cash reserves.
• Smaller producers who do not have the volume to
  use futures contracts or put options.
• Producers who prefer insurance to the futures
  market. No margin account.

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Some Risks Remain

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

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• Class web site
• http//www.econ.iastate.edu/chart/Classes/econ337
  /Spring2015/