k-state lrp workshops james mintert, g. art barnaby jr., kevin dhuyvetter department of agricultural...

K-State LRP Workshops

James Mintert, G. Art Barnaby Jr., Kevin Dhuyvetter

Department of Agricultural Economics

Kansas State University

KSU LRP Workshops

Purpose: Improve Cattle Producers’ Risk Management Skills

Teach producers • How LRP works• How to forecast basis• Provide experiential learning opportunity

to workshop participants involving use of crop insurance, LRP, cash contracting, & Put Options

LRP Workshop Partners

• RMA

• K-State Ag. Economics Department

• Kansas Farm Management Associations

• Kansas Livestock Association

Importance of Partners• RMA

– Funding for Program Development & Delivery

• K-State Ag. Economics Department

– Develop & Deliver Program

• KLA & KS Farm Management Associations

– Target Audience Identification

– Program Promotion

Marketing The Program• K-State Press Release• Direct mail to Extension Clientele by County Extension • Magazine Advertisement

– KLA Stockman, reaches about 8,000 producers • KLA Weekly Newsletter

– Calendar of upcoming KLA events

• Direct mail to all producers in KLA database• Direct mail to all Kansas Farm Management Association

members that have a cattle operation• Radio promotion on K-State’s daily “Ag Today” radio program

Workshop Format

Workshops Divided Into Two Parts

Part One

Presentations

1. How LRP works

2. Comparing LRP with CME Put Options

3. Improved basis forecasting

Workshop FormatWorkshops Divided Into Two Parts

Part Two

• Experiential Case Farm Workshop– Cow-Calf, Grain Farm Operation– Participants provided background information– Provided four decision periods– Make crop insurance decision – Make crop and cattle marketing decisions

Part One: LRP-What Is It?

• Livestock Risk Protection Insurance

• LRP for feeder cattle available in KS

– Provides protection against a decline in CME Feeder Cattle Price Index while you own cattle

– CME Feeder Cattle Price Index is a 7 day weighted average of cash feeder cattle prices across the U.S.

• LRP for slaughter cattle is also available in KS

– Provides protection against a decline in the 5 Area Weighted Average Price reported by USDA

How Does LRP Work?

• CME Feeder Cattle Index is used to cash settle Feeder Cattle Futures

– Since both CME Feeder Cattle futures and LRP use the CME Feeder Cattle Index to settle, purchase of LRP for Feeder Cattle is similar (but not identical) to purchasing a CME Feeder Cattle put option

• USDA’s 5 Area Weighted Average Price is used to settle LRP for Fed Cattle

– Purchase of LRP for Fed Cattle is similar (but not identical) to purchasing a CME Fed Cattle put option

To use LRP to protect against a price decline,

– you would purchase LRP insurance for a particular set of cattle (# of hd. & ending wt.)

– you must choose – Coverage Price (this is similar to an option’s Strike Price)

– End Date (e.g., the date coverage ends)

– Price you pay is known as LRP premium

How Does LRP Work?

LRP Feeder Cattle Premium Calculation Example

To calculate actual LRP premium you must know

Number of cattle ready for market (weighing less than 9.0 cwt) on End Date

Target Weight per head

Ownership share in cattle

Premium Calculation Example

Producer selects a coverage price which is a % of the Expected End Price published by RMA

Assume producer selects $100 per cwt. coverage price (e.g., 92% of RMA’s expected ending price)

For this coverage price, the rate is 1.449%

The premium subsidy is 13 percent


100 head * 7 cwt = 700 cwt.

700 cwt. * coverage price ($100) = $70,000

$70,000 * insured share (1.00) = $70,000 Insured

Value


$70,000 * rate of .01449= $1,014 Total Premium

$1,014 * .13 (subsidy) = $132 subsidy

$1,014 (total premium) minus $132 subsidy

= producer premium of $882

= $1.26/cwt. premium

Calculating Indemnity Indemnity is payable if actual ending price is

less than coverage price

Calculate indemnity by:

Multiplying number of head by target weight (in live cwt.)

Subtract actual ending price from coverage price

Multiplying total weight by difference between actual ending & coverage price

Indemnity Calculation ExampleOur example

An operation has 100 head of fed cattle Has a target weight of 7.00 cwt. per head Insured share is 100 percent

Indemnity Calculation Example Expected End Price for appropriate

insurance period is $109.25 per live cwt.

Producer selects a coverage price of $100 per cwt. (e.g., 92% of Exp. End Price)

Actual End Price is $80 per cwt. (e.g., CME Feeder Cattle Index = $80 on End Date)

Indemnity Calculation Example Subtracting actual ending price of $80 from

the coverage price of $100 = $20/cwt.

Recall that 100 head * 7.00 cwt = 700 cwt.

Multiplying 700 cwt. by $20/cwt = $14,000

Multiplying $14,000 by insured share of 1.00 = indemnity payment of $14,000

Indemnity Calculation Example What happens if actual ending price = $105?

Subtracting actual ending price of $105 from the coverage price of $100 = neg. $5/cwt.

Therefore, no indemnity payment is made to producer

This is analogous to a put option that expires worthless

LRP Coverage Prices & Levels

• Price guarantees change daily

• Premiums change daily

• Coverage available ranges from 70% to about 95% of Expected Ending Price, but maximum guarantee on most days is less than 95%

Premium Producer may obtain premium quotes via RMA’s

Premium Calculator available on USDA-RMA’s web site

Premium must be paid on day LRP insurance is purchased for coverage to be provided

Rates available at

http://www.rma.usda.gov/tools

Under livestock reports

Or use link on AgManager

www.agmanager.info/livestock/marketing

LRP Coverage Availability• Available from about 5 p.m. until 9 a.m. Central

Time during the week

• Not Available on Federal holidays

• Not Available if RMA web site down

Comparing LRP with CME Put Option Premiums for Similar Coverage

• LRP & Put do NOT expire on the same date, most of the time

• LRP & Put do not have the same expected price or strike value

• LRP is an European Option, no right to exercise

• So one can NOT compare cash cost because they do not have the same coverage & expiration dates


• LRP priced using option pricing model

• Calculate implied volility from current CME option premiums

• Calculate current “fair market” option premium for LRP based on LRP expiration date, European option, LRP expected market price, and LRP strike


1 Coverage Date 03/17/05 03/16/05 03/15/05 03/14/05 03/11/05

Section IV. Value of LRP based on Today's Market and LRP Expiration Date

17 LRP Estimated Market Price5 $103.588 $104.034 $103.994 $103.662 $103.690

18 KSU Est. September Volatility6 16.61 17.08 16.96 16.74 16.6819

$2.456 $2.440 $2.435 $2.474 $2.47720 KSU Est. "Put" Premium +Commission $2.56 $2.54 $2.54 $2.57 $2.58

Section V. Comparison of Put Vs. Current Market Value of LRP21 LRP - Est. Market Value of LRP Put $0.03 $0.03 $0.04 $0.05 ($0.02)22 % Current Market Value LRP Discount 1.13% 1.25% 1.52% 1.84% (0.81%)

KSU Estimated "Put" Premium to Provide Similar LRP Coverage based on Today's

Market7

LRP Premium = $2.58

Improving Basis Forecasting

What is Basis? Mathematically:

Basis = Cash price – Futures Price

Generally, basis is more predictable than cash or futures prices due to: Convergence

Futures and cash prices move together (same

fundamental conditions generally affect both markets)

Year-to-year stability

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

94%

95%

96%

97%

98%

99%

100%

101%

102%

103%

104%

Se

as

on

al I

nd

ex

5-6 cwt 6-7 cwt 7-8 cwt

Seasonal Price Index for Steers, Dodge City, KS -- 1995-2004

Basis patterns will vary by cattle weight

Cash Index Basis less Nearby Futures Basis (700-800 lb steers)

-14.00

-12.00

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00$

/cw

t

And There’s A Difference Between Cash Index (LRP) Basis and Futures Basis

Basis = Cash Price – Futures Price

Basis + Futures Price = Cash Price

Exp. Cash Price = Exp. Basis + Futures Price

Risk managers need basis forecasts

LRP users replace futures price with LRP coverage price minus premium

How do we use basis?

Basis as it relates to put optionsPut option strike (97.9%) $96.00

+ Expected basis 3.50

− Premium 2.13

= Expected minimum sale price $97.37

Based on May FC futures of $98.02 on 2/11/05

and expected selling date of mid May

Basis as it relates to LRP

LRP coverage level (93.9%) $92.29

+ Expected basis 4.00

− Premium 1.21

= Expected minimum sale price $95.08

Based on LRP quotes on 2/11/05 and ending

date of 5/13/05 (expected ending value =

$98.31, 13 week endorsement)

• Average over several years (years may vary depending on commodity) Average = expected value

• Measure variability (risk) Historical range (highs and lows),

standard deviation

Variability measure indication of risk

How should you forecast basis?

Feeder Cattle 2001 Basis and 3-year Historical Average Basis

-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Week

$/c

wt.

3-yr Avg Historical Basis 2001


-3.00

-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Week

$/c

wt.


Should forecasts consider current basis?


-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Week

$/cw

t.


Should forecast consider current basis?

?4-wk ahead forecast

?8-wk ahead forecast

How much should we “adjust” forecast by and how will this adjustment vary by time?

Optimal Current Information vs Forecast Time Horizon

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

4 8 12 16 20 24

Forecasting time horizon, weeks

Cu

rre

nt

info

rma

tio

n

1998-2002

1993-2002

Including Current Information Improves Forecasts But Value Declines As Forecast Horizon Increases

Mean Absolute Error of Alternative Basis Forecasts, 1993-2002

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

4 8 12 16 20 24

Forecasting time horizon, weeks

Mea

n a

bso

lute

err

or

(MA

E),

$/c

wt MAEopt

MAEno

MAEfull

Basing Forecasts Solely on Current Information Reduces Accuracy

• Basis is generally more predictable than prices.

• Very important when thinking about basis to make sure relevant/correct prices are used.

• Ignoring missing data in a multiple year average may lead to poor forecasts

• Basis is often forecasted using historical basis information, but incorporating “current” information can improve forecast accuracy.

Basis Conclusions

K-State Cattle Risk Management Workshop The John & Mary Sample Farm Grain Sorghum and Cow/Calf Problem by Dr. G. Art Barnaby, Jr. Dr. Jim Mintert

Dr. Kevin Dhuyvetter Aaron Gasper

Agricultural Economics Kansas State University

Check out our WEB page at

http://www.AgManager.info The purpose of this workshop is to familiarize you with the principles and practices of Risk Assessed Marketing (RAM). You will be asked to plan and implement a marketing program for the Cow/Calf Herd of a case farm, as well as the Grain Sorghum Enterprise. At the end of the workshop, you will have a better understanding of how farmers can employ different marketing strategies (including LRP for livestock) and, when combined with crop insurance, how these risk management tools can help producers to minimize financial risk and enhance farm income. Presented winter 2004 - 2005

Summary You are John or Mary Sample. With your spouse, you manage a cow/calf herd and a crop farm with grain sorghum and other crop enterprises. You have 440 cows, which will yield 200 steer calves that you will be able to sell at weaning, or background though the winter. Similar alternatives are available for the heifer calves but not included in the case study. Presently your crop acreage is split between grain sorghum and other crops. You intend to plant your 625 acres feedgrain base to milo with the balance of the acres planted to wheat and soybeans. There are several bank notes outstanding for land and machinery. You have budgeted out your milo, cow/calf, and other operations and you expect to have sufficient income to cover production costs, scheduled principal and interest payments, and living expenses. Your financial situation, however, is sensitive to changes in crop yields and market prices. So you are willing to consider some alternative pricing strategies to manage your price risk exposure. You are considering the purchase of both LRP, and crop insurance. You may purchase MPCI, CRC or Catastrophic crop insurance for your milo crop. Your assignment is to manage the production and marketing risk for the milo to be sold in October 2006. You will also have to manage marketing risk for steer calves to be sold either at weaning on October 25, 2006 or as feeders on February 21, 2007. Beginning in May 2006, you will have 2 opportunities to forward price any portion of your expected crop by forward cash contracts, or by purchasing put options (a form of "price insurance"). You will also be given one forward pricing opportunity for calves to be sold at weaning, and two forward pricing opportunities for the feeders if you chose to background the calves over the winter. The dates on which you may price the crop are May 17 and July 26. The dates on which you may price the calves or feeders are on June 28 and October 25. You may not sell more than 50,000 bushels of milo before harvest using any combination of the various marketing alternatives offered. Also, you may not forward price more than 200 calves before the selling dates.

If you change your mind, you may buy back and/or sell back any put options you purchased -- in effect "cancel" your "price" insurance. However, you may not cancel forward cash contracts or LRP contracts. All milo sales will be completed before or by October 25, 2006 (harvest). All livestock sales will be completed on or by October 25, 2006 or February 21 2007, depending on whether or not backgrounding is chosen as an option. Also at harvest, all forward contracts will be met (even if you have to buy grain on the cash market) and any put options will be offset. Also, all cash forward contracting of livestock will be settled at the time of cash sales. There will be no post-harvest storage or ownership and you will not be able to take any actions to “hedge” the counter-cyclical payment (CCP). All participants will receive the same direct payment and the same CCP (if a CCP is paid during the 2006/07 marketing year). You will not know what your "actual" yield will be until harvest. At that time you will "draw" one of four possible yields. The probability of suffering a crop loss will be provided at the time crop insurance is to be purchased (March 15, 2006). If you background any or all of your steer calves, milo for feed rations will be taken off your total cash milo crop and fed in the backgrounding enterprise.

Setting Up The Case Farm

• Participants are provided

Enterprise budgets for

– Grain sorghum

– Cow-calf

– Steer backgrounding

Setting Up The Case Farm

• Participants must make crop insurance coverage selection at outset

Dryland Grain Sorghum: April 15625.0

Please Circle only ONE Dollar Amount ! (Rounded to $100)

MPCI CRC$2.35 $2.50

Subsidy P Election CBOT

1. 80% Coverage $8,700 $10,700

2. 75% Coverage $5,700 $7,000

3. 70% Coverage $3,800 $4,700

4. Catastrophic $100 NONE

PROBABILITY OF YIELD AND CAUSE OF LOSSES (IF ANY)

Total

Yield Prob Cause Production

16 20% Other Causes 10,000

40 25% Other Causes 25,000

80 30% No Loss 50,000

96 25% No Loss 60,000

WORKSHOP YIELD "DRAWS"

Number of Acres

______ ______

______ ______

______ ______

Assume a Market Price of $2.00

SUMMARY, Dryland Grain Sorghum: April 15(Payments Rounded to $ 1,000)

Total Prem. <------------Yield-------------->

Cov Premium per Ac. 16 40 80$2.35 $3.00

Total Bushels MPCI

40,000 31,333 80% $8,700 $13.92 $71,000 $35,000 $0

37,500 29,375 75% 5,700 9.12 $65,000 $29,000 $0

35,000 27,417 70% 3,800 6.08 $59,000 $24,000 $0

15,000 11,750 CAT 100 0.16 $21,000 $0 $0

CRC

42,553 40,000 80% 10,700 17.12 $80,000 $50,000 $0

39,894 37,500 75% 7,000 11.20 $74,000 $44,000 $0

37,234 35,000 70% 4,700 7.52 $68,000 $38,000 $0

______ ______

______ ______

______ ______

Assume a Market Price of $3.00 SUMMARY, Dryland Grain Sorghum: April 15

(Payments Rounded to $ 1,000) Total Prem. <------------Yield-------------->

Cov Premium per Ac. 16 40 80$2.35 $3.00

Total Bushels MPCI

40,000 31,333 80% $8,700 $13.92 $71,000 $35,000 $0

37,500 29,375 75% 5,700 9.12 $65,000 $29,000 $0

35,000 27,417 70% 3,800 6.08 $59,000 $24,000 $0

15,000 11,750 CAT 100 0.16 $21,000 $0 $0

42,553 40,000 80% 10,700 17.12 $90,000 $45,000 $0

39,894 37,500 75% 7,000 11.20 $83,000 $38,000 $0

37,234 35,000 70% 4,700 7.52 $75,000 $30,000 $0

CRC

Case Problem, 2006 Weekly December Corn Futures (High, Low, Close)

$2.20

$2.25

$2.30

$2.35

$2.40

$2.45

$2.50

$2.55

$2.60

$2.65

$2.70

1/4/06 2/1/06 3/1/06 3/29/06 4/26/06 5/24/06 6/21/06 7/19/06 8/16/06 9/13/06 10/11/06 11/8/06

May 17 $2.35

May 17th Scenario

MinimumExpected Put Expected

+ Harvest - Option = NetBasis Premium Price

+ - = WHAT QTY?

HOW?WHY?

= $2.35CBOT CBOTDec Option CALL Put Dec Option CALL PutStrike Price Premium Premium Strike Price Premium Premium

2.80 0.03 0.47 2.20 0.23 0.082.50 0.09 0.24 2.10 0.30 0.052.40 0.13 0.182.30 0.18 0.13

- - - - - - - - - - - - - - - - - - - - - - - ($/Bu.) - - - - - - - - - - - - - - - - - - - - - - -

Foward Contract Bid = $1.95 for Oct 25 Delivery (Avg Basis -$0.40/bu.)

CBOT Dec Corn Futures

CBOT Put Option

Strike Price

SHOULD I SELL SOME MILO TODAY? (Y/N)

Pricing Opportunities for Milo on 05/17/06 To Be Delivered at Harvest

$2.30 $-.40 $0.13 $1.77

YES / NO

$2.30 $-.40 $0.13 $1.77

YES / NO 15,000

10,000 BU. FORWARD CONTRACT, and 5,000 BU. With a PUT

I UNDERSTAND FORWARD CONTRACT & WANTED TO COMPARE WITH PUT


+ Harvest - Option = NetBasis Premium Price

+ - = WHAT QTY?

HOW?WHY?

= $2.35CBOT CBOTDec Option CALL Put Dec Option CALL PutStrike Price Premium Premium Strike Price Premium Premium

2.80 0.03 0.47 2.20 0.23 0.082.50 0.09 0.24 2.10 0.30 0.052.40 0.13 0.182.30 0.18 0.13

- - - - - - - - - - - - - - - - - - - - - - - ($/Bu.) - - - - - - - - - - - - - - - - - - - - - - -

Foward Contract Bid = $1.95 for Oct 25 Delivery (Avg Basis -$0.40/bu.)

CBOT Dec Corn Futures

CBOT Put Option

Strike Price

SHOULD I SELL SOME MILO TODAY? (Y/N)

Pricing Opportunities for Milo on 05/17/06 To Be Delivered at Harvest

Name_________________________________ TotalPymt

Transaction May 17 Jul 26 Harvest RecvdPUTSStrike Price _______________ _______________Premium _______________ _______________ Quantity Bought _______________ _______________ Quantity Sold xxxxxxxxxxxxxx _______________ Gain (Loss)/Bu _______________ _______________Total Gain (Loss) _______________ _______________ _______________CALLSStrike Price _______________ _______________Premium _______________ _______________ Quantity Bought _______________ _______________ Quantity Sold xxxxxxxxxxxxxx _______________ Gain (Loss)/Bu _______________ _______________Total Gain (Loss) _______________ _______________ _______________Forward Cash ContractPrice Bid _______________ _______________ Quantity _______________ _______________ Total Revenue _______________ _______________ _______________Bushels Produced _______________ Harvest Sales- Bu. Fed to Steers _______________ Price @ Harvest _______________- Bu. Frwrd Contract _______________ Quantity Delivered _______________Quantity Delivered _______________ Hrvst Sales Revenue _______________ _______________

Total Revenue _______________ -------------------------------------------------------------------------------

Average Price Received = Total Payments Received / Total bushels Produced$_________ (Bushel) = $ __________________/ __________________ Bushels-Bushels Fed

MARKETING LEDGER

$2.30

$0.13

5,000

$1.95

10,000

$19,500

Case Problem, 2006 Weekly CME October Feeder Cattle Futures (High, Low, Close)

$98.00

$100.00

$102.00

$104.00

$106.00

$108.00

$110.00

$112.00

$114.00

$116.00

1/4/06 2/1/06 3/1/06 3/29/06 4/26/06 5/24/06 6/21/06 7/19/06 8/16/06 9/13/06 10/11/06

June 28 $112.00

June 28th ScenarioFor Calf Sales inOctober 2006

= $112.00= $123.18 Adjusted 110% for Steers less than 6 cwt

Average 5.25 cwt steer LRP basis in late October is -$1/cwt

CME Oct Feeder Cattle Options < 600 Steer 17 WK LRP Expires on Oct 25Oct Option CALL Put LRP LRP Subsidized Subsidized

Strike Price Premium Premium Coverage Coverage LRP LRP

($/cwt.) (Cont) ($/cwt.) (Cont) Level Price Rates/CWT Rates/Head

116.00 3.47 1,735 7.44 3,722 93% 114.56$ $1.59 8.34$

112.00 4.07 2,035 4.07 2,035 91% 112.09$ $1.17 6.13$

110.00 5.42 2,711 3.44 1,718 89% 109.63$ $0.85 4.44$

108.00 6.59 3,296 2.62 1,309 87% 107.17$ $0.61 3.18$

106.00 8.20 4,099 2.24 1,119104.00 9.61 4,803 1.66 829102.00 11.38 5,692 1.45 725

Forward Contract Bid = $118.00 cwt/ $619.50 hd for Steers Oct 25 DeliveryAverage 5.25 cwt steer CME basis in late October is + $8/cwt

June 28, 2006MARKET INDICATORS: Feeder cattle prices have shot up over the previous few weeks to $112. Continued strong retail demand for beef has been credited for pushing live cattle cash prices higher. Some market analysts are suggesting availability of lower cost poultry and pork will limit further gains in the fed cattle market. Seasonal increases in cattle supplies this summer could begin to weigh on prices.

CME Oct Feeder Cattle FuturesLRP Oct 25 Expected Ending Value

SHOULD I SELL SOME Steers calves TODAY? (Y/N) _________WHAT QTY?

HOW?WHY?

= $112.00= $123.18 Adjusted 110% for Steers less than 6 cwt

Average 5.25 cwt steer LRP basis in late October is -$1/cwt

CME Oct Feeder Cattle Options < 600 Steer 17 WK LRP Expires on Oct 25Oct Option CALL Put LRP LRP Subsidized Subsidized


($/cwt.) (Cont) ($/cwt.) (Cont) Level Price Rates/CWT Rates/Head

116.00 3.47 1,735 7.44 3,722 93% 114.56$ $1.59 8.34$

112.00 4.07 2,035 4.07 2,035 91% 112.09$ $1.17 6.13$

110.00 5.42 2,711 3.44 1,718 89% 109.63$ $0.85 4.44$

108.00 6.59 3,296 2.62 1,309 87% 107.17$ $0.61 3.18$

106.00 8.20 4,099 2.24 1,119104.00 9.61 4,803 1.66 829102.00 11.38 5,692 1.45 725

Forward Contract Bid = $118.00 cwt/ $619.50 hd for Steers Oct 25 DeliveryAverage 5.25 cwt steer CME basis in late October is + $8/cwt

Pricing Opportunities for Steer Calves on 06/28/06 To Be Delivered as 5.25 cwt steers on October 25, 2006

CME Oct Feeder Cattle FuturesLRP Oct 25 Expected Ending Value

YES / NO 110 headForward Contract 10 weaning steer calves, 10 LRP, & 1 Oct Put

COMPARE LRP with a PUT


+ CME - Option = NetBasis Premium Price

+ - =

MinimumExpected LRP Expected

+ LRP - Premium = Net(in CWT) Basis (in CWT) Price

+ - =

Pricing Opportunities for Steer Calves on 06/28/06 To Be Delivered as 5.25 cwt steers on October 25, 2006

CMEPut Option

Strike Price

10/25/06 LRP Coverage Price

$108 $8 $2.62 $113.38

$114.56 -$1 $1.59 $111.97

Case Problem, 2007 Weekly CME March Feeder Cattle Futures (High, Low, Close)

$88.00

$90.00

$92.00

$94.00

$96.00

$98.00

$100.00

$102.00

$104.00

$106.00

1/4/06 2/18/06 4/4/06 5/19/06 7/3/06 8/17/06 10/1/06 11/15/06 12/30/06 2/13/07

June 28 $100.00

June 28th ScenarioFor Feeder Salesin February 2007

Pricing Feeder Steers for Feb 2007 Delivery

SHOULD I SELL SOME feeder Steers TODAY? (Y/N) _________WHAT QTY?

HOW?

= $100.00= $102.86 Steers weighing 6 to 9 cwt

Average 8 cwt steer LRP basis in late February is -$3/cwt

CME Mar Feeder Cattle Options 600-900# Steer 34 WK LRP Expires on Feb 21, 2007

Mar Option CALL Put LRP LRP Subsidized Subsidized


($/cwt.) (Cont) ($/cwt.) (Cont) Level Price Rates/cwt Rates/Head

104.00 4.81 2,404 8.75 4,374 94% 96.69$ 4.23$ 33.85$

100.00 6.46 3,231 6.46 3,231 92% 94.63$ 3.69$ 29.54$

98.00 7.43 3,715 5.46 2,730 90% 92.57$ 3.21$ 25.71$

96.00 8.50 4,248 4.56 2,278 88% 90.51$ 2.79$ 22.32$

94.00 9.66 4,830 3.75 1,87592.00 10.92 5,461 3.04 1,52090.00 12.28 6,138 2.43 1,213

Forward Contract Bid = $97.00 cwt/ $776.00 hd for Feeder Steers Feb 21, 2007 DeliveryAverage 8 cwt steer CME basis in late February is + $1/cwt

Pricing Opportunities for Steers on 6/28//06 to be delivered as 8.0 cwt steers on February 21, 2007

LRP Feb 21 Expected Ending ValueCME Mar 07 Feeder Cattle Futures


SHOULD I SELL SOME feeder Steers TODAY? (Y/N) _________WHAT QTY?

HOW?

= $100.00= $102.86 Steers weighing 6 to 9 cwt


CME Mar Feeder Cattle Options 600-900# Steer 34 WK LRP Expires on Feb 21, 2007

Mar Option CALL Put LRP LRP Subsidized Subsidized



104.00 4.81 2,404 8.75 4,374 94% 96.69$ 4.23$ 33.85$

100.00 6.46 3,231 6.46 3,231 92% 94.63$ 3.69$ 29.54$

98.00 7.43 3,715 5.46 2,730 90% 92.57$ 3.21$ 25.71$

96.00 8.50 4,248 4.56 2,278 88% 90.51$ 2.79$ 22.32$

94.00 9.66 4,830 3.75 1,87592.00 10.92 5,461 3.04 1,52090.00 12.28 6,138 2.43 1,213

Forward Contract Bid = $97.00 cwt/ $776.00 hd for Feeder Steers Feb 21, 2007 DeliveryAverage 8 cwt steer CME basis in late February is + $1/cwt


LRP Feb 21 Expected Ending ValueCME Mar 07 Feeder Cattle Futures

YES / NO 80 headFORWARD CONTRACT 10 Feeders, 10 LRP & 1 Mar PUT



+ - =



+ - =

CMEPut Option

Strike Price


LRP Expired 2/21/07 Coverage

Price

$96 $1 $4.56 $92.44

$96.69 -$3 $4.23 $89.46

Name_________________________________ Total

PymtTransaction Jun 28 Jun 28 Oct 25 RecvdPUTSStrike Price ________ ________ ________Premium/Contract ________ ________ ________ Contracts Bought ________ ________ ________ Contracts Sold ________ ________ ________Premium/Contract @ Offset ________ ________ ________ Gain (Loss)/Contract ________ ________ ________Total Gain (Loss) ________ ________ ________ ________CALLSStrike Price ________ ________ ________Premium/Contract ________ ________ ________ Contracts Bought ________ ________ ________ Contracts Sold ________ ________ ________Premium/Contract @ Offset ________ ________ ________ Gain (Loss)/Contract ________ ________ ________Total Gain (Loss) ________ ________ ________ ________LRP Steers 17 Wk LRP 34 WK LRP 17 Wk LRP

Coverage Price/ cwt ________ ________ ________Premium/ Head ________ ________ ________ Head Insured ________ ________ ________Gross Indemnity/Head ________ ________ ________Net Indemnity/Head ________ ________ ________

Total Gain (Loss) ________ ________ ________ ________ (= Net Indemnity X No. Head)

Total Gain/Loss from LRP/Options ________

OPTIONS & LRP MARKETING LEDGER

Offset in Oct

Offset in Feb

Offset in Feb

$108

$1,309

1

$96

$2,278

1

$114.56

$8.34

10

$96.69

$33.85

10

90 Calves 60 Steers

50,000#/90Hd = 555# steer

50,000#/60Hd = 833# steer

Total of 150 steers priced using 1 Oct put & 1 Mar put and 20 steers priced using LRP

TotalPymt

Transaction Jun 28 Oct 25 Feb 21 RecvdGain/Loss from LRP/Options (other side of page) ________Weaning Forward Cash Contract ( Steers)Weaning Price Bid/head ________ Number Head ________Contracted Weaning Sales ________ ________Cash Sales/head ________ Number Head ________Cash Weaning Sales ________ ________Feeder Forward Cash ContractFeeder Price Bid/head ________ ________ Number Head ________ ________Contracted Feeder Sales ________ ________ ________Cash Price/head ________ Number Head ________Cash Feeder Sales ________ ________

Total Steer Marketing Revenue ________

Total Cash Cost/Calf $545 Number Weaning Head Sold ________ ________

Total Other (Non-Milo) Costs for Feeder $635 Number Feeders Sold ________ ________

________________

Bushels of Milo/ head 15Head Retained for Feeders ________ Total Bushels Fed ________Total Milo Fed bu ______bu

Total Costs

CASH & CONTRACT MARKETING LEDGER

Net Steers Sales (Revenue - Costs

$619.50

10$6195.00

$776

10

$7,760

Additional Marketing Decisions

• Milo decision in late July

• Calf-Feeder Cattle Decision in late October

• Harvest yields drawn from distribution in late October

• Results from CME put options, LRP insurance, forward contracts recorded

Case Problem, 2006 Weekly CME October Feeder Cattle Futures (High, Low, Close)

$98.00

$100.00

$102.00

$104.00

$106.00

$108.00

$110.00

$112.00

$114.00

$116.00

1/4/06 2/1/06 3/1/06 3/29/06 4/26/06 5/24/06 6/21/06 7/19/06 8/16/06 9/13/06 10/11/06 11/8/06

June 28 $112.00

Oct. 25 $102.00

Oct. 25th ScenarioFor Calf Sales

WHAT QTY?

HOW?

= $102.00

= $100.00

CME Oct Feeder Cattle Options < 600 Steer 17 WK LRP Expires on Oct 25Oct Option CALL Put LRP LRP Gross Gross

Strike Price Premium Premium Coverage Coverage Indemnity Indemnity

($/cwt.) (Cont) ($/cwt.) (Cont) Level Price CWT Head

116.00 0.00 0 14.00 7,000 93% 114.56$ $4.56 $23.93

112.00 0.00 0 10.00 5,000 91% 112.09$ $2.09 $10.99

110.00 0.00 0 8.00 4,000 89% 109.63$ $0.00 $0.00

108.00 0.00 0 6.00 3,000 87% 107.17$ $0.00 $0.00

106.00 0.00 0 4.00 2,000104.00 0.01 3 2.01 1,003102.00 0.40 199 0.40 199

October 25, 2006

Steer Calves on 10/25/06 Cash Bid = $110.00 cwt/ $577.50 hd Immediate Delivery

MARKET INDICATORS: Despite the falling feedgrain prices since August, feeder cattle prices have declined. Failure to reopen the Japanese market has depressed fed and feeder cattle prices. Prospects for opening the Japanese market anytime soon are dim.

SHOULD I SELL SOME Steers TODAY? (Y/N)

CME Feeder Cattle Index

CME Oct Feeder Cattle Futures

YES / NO 10 headCash Sale 10 steers at weaning

Name_________________________________ Total






Offset in Oct

Offset in Feb

Offset in Feb

$108

$1,309

1

$3,000$1,691

$1,691

$96

$2,278

1

$114.56

$8.34

10

$15.59

$155.90

$96.69

$33.85

10

60 Steers

$23.93


SHOULD I SELL SOME Steers TODAY? (Y/N) __________ WHAT QTY? ____________HOW?

= $98.00= $99.71


CME Mar Feeder Cattle Options 600-900# Steer 17 WK LRP Expires on Feb 21, 2007Mar Option CALL Put LRP LRP Subsidized Subsidized



104.00 1.85 923 7.80 3,898 94% 93.73$ $2.17 17.33$

100.00 3.17 1,583 5.15 2,575 90% 89.74$ $1.28 10.23$

98.00 4.04 2,020 4.04 2,020 86% 85.75$ $0.70 5.63$

96.00 5.07 2,534 3.09 1,543 82% 81.77$ $0.36 2.88$

94.00 6.25 3,126 2.29 1,14392.00 7.59 3,794 1.64 81990.00 9.06 4,532 1.13 566

Forward Contract Bid = $96.00 cwt/ $768.00 hd for Feeder Steers Feb 21, 2007 DeliveryAverage 8 cwt CME steer basis in late February is + $1/cwt

CME Mar 07 Feeder Cattle Futures

Pricing Opportunities for Steer Calves on 10/25/06 To Be Delivered in February 2007 as Feeder Calves

LRP Feb 21 Expected Ending Value Steers weighing 6 to 9 cwt

Case Problem, 2007 Weekly CME March Feeder Cattle Futures (High, Low, Close)

$88.00

$90.00

$92.00

$94.00

$96.00

$98.00

$100.00

$102.00

$104.00

$106.00

1/4/06 2/18/06 4/4/06 5/19/06 7/3/06 8/17/06 10/1/06 11/15/06 12/30/06 2/13/07

June 28 $100.00

Oct. 25 $98.00



+ - =



+ - =

CMEPut Option

Strike Price


2/21/07 LRP Coverage Price

$96 $1 $3.09 $91.91

$93.73 -$3 $2.17 $88.56


SHOULD I SELL SOME Steers TODAY? (Y/N) __________ WHAT QTY? ____________HOW?

= $98.00= $99.71


CME Mar Feeder Cattle Options 600-900# Steer 17 WK LRP Expires on Feb 21, 2007Mar Option CALL Put LRP LRP Subsidized Subsidized



104.00 1.85 923 7.80 3,898 94% 93.73$ $2.17 17.33$

100.00 3.17 1,583 5.15 2,575 90% 89.74$ $1.28 10.23$

98.00 4.04 2,020 4.04 2,020 86% 85.75$ $0.70 5.63$

96.00 5.07 2,534 3.09 1,543 82% 81.77$ $0.36 2.88$

94.00 6.25 3,126 2.29 1,14392.00 7.59 3,794 1.64 81990.00 9.06 4,532 1.13 566

Forward Contract Bid = $96.00 cwt/ $768.00 hd for Feeder Steers Feb 21, 2007 DeliveryAverage 8 cwt CME steer basis in late February is + $1/cwt

CME Mar 07 Feeder Cattle Futures


LRP Feb 21 Expected Ending Value Steers weighing 6 to 9 cwt

YES / NO 80 headFORWARD CONTRACT 10 Feeders, 10 LRP & 1 PUT

Name_________________________________ Total






Offset in Oct

Offset in Feb

Offset in Feb

$108

$1,309

1

$3,000$1,691

$1,691

$96

$2,278

1

$96

$1,543

1

$114.56

$8.34

10$23.93

$15.59

$96.69

$33.85

10

$93.73

$17.3310

$155.90

Total of 120 steers priced using 2 Mar puts and 20 steers priced using LRP

60 Steers60 Steers

TotalPymt

Transaction Jun 28 Oct 25 Feb 21 RecvdGain/Loss from LRP/Options (other side of page) ________Weaning Forward Cash Contract ( Steers)Weaning Price Bid/head ________ Number Head ________Contracted Weaning Sales ________ ________Cash Sales/head ________ Number Head ________Cash Weaning Sales ________ ________Feeder Forward Cash ContractFeeder Price Bid/head ________ ________ Number Head ________ ________Contracted Feeder Sales ________ ________ ________Cash Price/head ________ Number Head ________Cash Feeder Sales ________ ________

Total Steer Marketing Revenue ________

Total Cash Cost/Calf $545 Number Weaning Head Sold ________ ________

Total Other (Non-Milo) Costs for Feeder $635 Number Feeders Sold ________ ________

________________

Bushels of Milo/ head 15Head Retained for Feeders ________ Total Bushels Fed ________Total Milo Fed bu ______bu

Total Costs

CASH & CONTRACT MARKETING LEDGER

Net Steers Sales (Revenue - Costs

$619.5010

$6,195

$776

10

$7,760

$577.50

10

$5,775

$768

10

$7,680

1 . Acres Harvested [See "A." on Yield Slip"] Ac. 625.0$ +

2 . Average Yield [See "B." on "Yield Slip"] Bu\Ac.

3 . Total Bushels [See "C." on "Yield Slip"] Bus.

4 . Ttl Milo Mrkt Income [See Mktng Ledger] $ +

5 . Net Steer Sales [ Cash& Contract MKT Ledger] $ +

6 . Crop Insurance Pymnts [See "Payout" Tbl] $ +

7 . LDP Payment $ + NONE

8 . Counter Cyclical Payments $12,000 __

9 . Direct Payments $13,000$ +

10 . Crop Insurance Premium Expenses $ -

11 . Ttl Crop Prod Expns [See "D." on "Yield Slip"] $ -

12 . Net Income [Lines (4+5+ 6+ 7+ 8+9) - (10+11)] $

Calculate your net revenue for your enterprise

50,000

80

$108,000

1 . Acres Harvested [See "A." on Yield Slip"] Ac. 625.0$ +

2 . Average Yield [See "B." on "Yield Slip"] Bu\Ac.

3 . Total Bushels [See "C." on "Yield Slip"] Bus.

4 . Ttl Milo Mrkt Income [See Mktng Ledger] $ +

5 . Net Steer Sales [ Cash& Contract MKT Ledger] $ +

6 . Crop Insurance Pymnts [See "Payout" Tbl] $ +

7 . LDP Payment $ + NONE

8 . Counter Cyclical Payments $12,000 __

9 . Direct Payments $13,000$ +

10 . Crop Insurance Premium Expenses $ -

11 . Ttl Crop Prod Expns [See "D." on "Yield Slip"] $ -

12 . Net Income [Lines (4+5+ 6+ 7+ 8+9) - (10+11)] $

Calculate your net revenue for your enterprise

$102,150

50,000

80

$38,188

$0

$108,000

$7,000

$50,338

+

++

+

+

LRP Summary

LRP does not guarantee a cash priceLRP does not guarantee a cash price

LRP protects against a negative change in CME LRP protects against a negative change in CME Cash Index PriceCash Index Price

LRP does NOT guarantee the basisLRP does NOT guarantee the basis

Policy does not cover any other perilPolicy does not cover any other peril

LRP Summary

• LRP premiums are similar to comparable CME put options

– This means USDA subsidy does not provide an incentive to buy LRP vs. CME Put Options

• Orders are filled at the stated premium

– Deferred options are sometimes thinly traded & it’s difficult to execute option transactions at quoted premiums

LRP Advantages Insure the exact number of head that you choose

Flexible contract size matches “small” operations vs.

Feeder cattle futures that represents about 67 steers weighing 750 pounds

Live cattle futures that represents about 33 steers weighing 1200 pounds

Can incrementally minimum price a few head at a time

Producer’s LRP Disadvantages• Cannot exercise or cancel LRP contract

– Inability to cancel contract inhibits marketing flexibility

– Also an issue if cattle are sold early because of drought damaged pastures.

• Can not roll up the LRP coverage in a rising market

– CME options offer flexibility of “rolling up” coverage

• Contracts only offered in 4 week increments

– Lack of flexibility creates extra basis risk

Producer’s LRP Disadvantages

• Coverage is always greater than 5% out of the money and in some cases almost 10%

• If company exceeds its premium limit, producers with that company’s policy can not buy additional SCEs even though other companies still have capacity to sell

LRP Advantages for Lenders

• Lenders may prefer LRP over a put to cover loan collateral

• Producers can’t cancel the coverage

• LRP is insurance, so Lenders can take a security interest in the contract

Who Attended The Workshops?

Cow-Calf Operation 50%

Cattle Backgrounding Operation 42%

Cattle Feeding Operation 21%

Ag. Lender 18%

Crop Insurance Agent 6%

Commodity Broker 1%

Other 15%

How Effective Are The LRP Workshops?Participant Evaluation Results

On a scale of 1 (very useful) through 5 (not useful),

1. How would you rate the overall usefulness of the workshop?

1.70

2. How would you rate the usefulness of the "case farm" exercise?

1.79

How Effective Are The LRP Workshops?Participant Evaluation Results

On a scale of 1 (very useful) through 5 (not useful),

3. Would you recommend this workshop to others who have a stake in the cattle business?

1.63

How Much Did Participants Learn?Pre & Post Workshop Reviews

1. Are there any limitations regarding how many head of feeder cattle can be insured via LRP for Feeder Cattle? If so, what are the limitations?

2. Who can you purchase LRP insurance from?

3. When purchasing LRP Insurance for Feeder Cattle, what is the maximum insurance coverage price that you can purchase for your feeder cattle on any given day?

4. What published price is the LRP Expected End Value for feeder cattle base on?


5. Assume that you purchased LRP Insurance for 50 head of steers that you own and that you expect the steers will weigh 800 lbs at the end of the coverage period. Also assume that your Coverage Price is $104/cwt and that the CME Feeder Cattle Index value during the ending week is $100/cwt. What indemnity, if any, will you receive from your LRP insurance policy?

6. Have you ever used CME put options?


• Participants that had used options previously earned higher scores on pre-workshop review than participants that had no options experience

• 47% correct vs 37% correct


Improvement from Pre- to Post Workshop Evaluation

0%

5%

10%

15%

20%

25%

30%

35%

-1 0 1 2 3 4 5

Increase in number of questions answered correctly

Fre

qu

ency

Where Do We Go From Here?

• Anticipate conducting more workshops in fall and winter 2005-2006

• Workshop improvements

consider modifying structure so the entire workshop focuses on case farm with short lectures integrated within the case farm at “teachable moments”

K-State LRP Workshops

Need More Information:Email

[email protected]

k-state lrp workshops james mintert, g. art barnaby jr., kevin dhuyvetter department of agricultural...

Documents

cattle slide

lrp insurance

fed cattle purchase

feeder cattle available

slaughter cattle

cme feeder cattle index

cme fed cattle

cme feeder cattle futures