PrinciplesofHedgingLivestock
UsingFuturesMarkets
BrianCoffey
KSURiskandProfitConference
Manhattan,KS
August16Ŋ17,2018
HedgingConcepts
Hedgingallowssellersorbuyersofaproducttomanagetherisk
associatedwiththesaleorpurchaseofthatproduct
Ahedgeinvolvesequal andopposite positionsincash and
futures markets
Hedgingreducespriceriskbecausethesepositionsoffseteach
other—ifonegains,theotherloses
Forourpurposeskeep
inmind…hedgingispurelyarisk
managementstrategy
HedgingConcepts:Arbitrage
Whydofuturesandcashpositionsoffseteachother?
Arbitrage
HedgingConcepts:Arbitrage
FuturesandCashMarketsforacommodityareconnectedeither
bydeliveryoracashindexbasedonthecashcommodity
Tradersallovertheworldcanwatchthecashandfuturesprices
forarbitrageopportunities
Ifmarketsareefficient,allthistradingactivitywillbringtogether
cashandfutures
pricesforcommodityinasomewhat
predictableway
HedgingConcepts:Basis
Thedifferencebetweencashandfuturespriceisreferredtoas
basis
Basisisusuallydefinedascashminusfutures
Grainbasisisnormallyanegativenumber(futuresprice>cash
price)butisoftenreportedasapositivenumber
Forstorablecommoditiesthataredeliverable,basisshould
reflectcarry.
Carryismadeupofstoragecost,costof
transportationtotheterminalmarket,andriskofholdinggrain.
Basisreflectslocalsupplyanddemandconditions
HedgingConcepts:Basis
Livestockbasiscanbepositiveornegativeandhasstrong
seasonalcomponents
FornonŊstorable(orsemiŊstorable)commoditiesbasisisnotas
straightforward.Weagreethatitreflectslocalsupplyand
demandconditions.
Basisshouldalsoreflectdifferencesincashmarketlivestock
comparedtofuturescontractspecifications
CashPosition
Longposition isonewhereyouhave(orhaveinvestedsothat
yousoonwillhave)somequantityofthephysicalcommodity
thatyouplantosell.Youhaveanexcess.
AcowŊcalfoperatorwithcalvesoncowstobesoldas600Ŋpound
weanedcalveshaslongcashpositioninfeedercalves
Acattlefeederwhobuysfeedercattlewiththeintenttofinishandsell
themaslivecattlehaslongcashpositioninlivecattle
Ahog
finishingoperationwithweanedpigsonfeedwiththeintentof
sellingthemasmarkethogshasalongcashpositioninmarkethogs
(leanhogs)
CashPosition
Shortposition isonewhereyouneed(orhaveinvestedsothat
yousoonwillneed)tobuysomequantityofthephysical
commodity.Youhaveadeficit.
Acattlefeederwhoplanstobuyfeedercattletofillpensatsometime
inthefuture,withtheintenttofinishandsellthemaslivecattlehas
shortcashpositioninfeedercattle
Abeefpackerwhoplanstobuylivecattletobeslaughteredinthe
futureisshortinthelivecattlecashmarket
Aporkpackerwhoplanstobuymarkethogstobeslaughteredinthe
futurehasshortcashpositioninmarkethogs
FuturesMarketPosition
Youestablishafuturesmarketpositionbyenteringintoa
futurescontract
Afuturescontractisaveryspecificinstrumentthatallows
marketparticipantstocommittoeitherdeliveringoraccepting
deliveryofacommodityoryouagreetosettlethecontract
againstsomefinancialmeasure
Thecontractspecifiesa
deliverymonth,quantity,quality,
specifications,proceduresforsettlement,howdisputesare
arbitrated,etc.
Thecontractisalegallybindingdocument
CMEGroup LivestockContracts
Commodity Quantity Settlement
FeederCattle 50,000lbs
live
weight
CashIndex:
700Ŋ899lb feedersteers,MedŊLarge#1andMedŊ
Large#1Ŋ2;8total weightdivisions
Directsales in12States
Availabledailyprices
LiveCattle 40,000lbs
live
weight
PhysicalDelivery:
Live steersorheifersORcarcasses
65%Choice,35%Select,YG3(after10/18)
1,050Ŋ1,500lbs live;600
Ŋ900lbs carcass
Beefbreeds
LeanHogs 40,000lbs
live
weight
CashIndex:
Basedonpriordayslaughteredswinereport
Average netprice
Twodays’data
FuturesMarketPosition
Apersonwhocommitstodeliveringissaidtohavesold a
contractorisshort acontract
Apersonwhocommitstoacceptingdeliveryissaidtohave
bought acontractorislong acontract
Everyfuturescontractthatistradedhasapersonwhoislong
andaperson
whoisshort.Itisazerosumgame.
FinancialSettlementandDelivery
Forcontractssettledagainstacashindexandthereisnochance
ofphysicaldelivery.
However,theconceptisexactlythesame
Underlyinglivestockcashindicesarebasedonnegotiatedcash
markettrade
Ifyourcontractexpiresyoumustoffsetitbasedonthecash
index(ratherthanwithactual
animals)
Ifyouareshortfutures…youmustbuybackthecontract
quantityattheindexprice
Ifyouarelongfutures…youmustsellbackthecontractquantity
attheindexprice
HedgingConcepts:Arbitrage
Futuresmarkettraderscanformabiasconcerningwhether
priceswillmoveonewayoranother,relativetocashprices
Theythentradebasedonthisbias
Traderswhoareactiveinamarketforthesolepurposeof
makingmoneyontheirtradesareknownasspeculators
Thougha
bitmorecomplicatedthanourexample,theiractions
tocapitalizeonarbitrageopportunitiesconnectfuturesandcash
pricesforagivencommodity
HedgingConcepts:FunctionofFutures
Markets
Theabilitytotradefuturescontractsallowsfortwoimportant
activitiestooccur
1. PriceDiscovery
2. TransferofRisk
Speculatorstakeonpriceriskwiththehopesofmakingmoney
Hedgerspaytoavoidpricerisk
Speculatorsarenecessaryforhedgingtotakeplace
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Example:LongFeederCattleHedgebyaCattleFeeder
Time CashFeederCattle FeederCattleFutures Basis
Action
Priceper
cwt
Position Action
Priceper
cwt
Position
January18,
2018
Planningto
place
feeder
cattlein
March.
BuyMarch
feeder
cattle
futures
contracts
March15,
2018
Purchase
feeder
cattle
SellMarch
feeder
cattle
futures
contracts
Net
Example:LongFeederCattleHedgebyaCattleFeeder
Time CashFeederCattle FeederCattleFutures Basis
Action
Priceper
cwt
Position Action
Priceper
cwt
Position
January18,
2018
Planningto
place
feeder
cattlein
March.
$146 Short
BuyMarch
feeder
cattle
futures
contracts
$147 Long Ŋ$1.00
March15,
2018
Purchase
feeder
cattle
SellMarch
feeder
cattle
futures
contracts
Net
HedgingExamples
Whatdoesthelonghedgerexpecttopayforthefeeders?
ExpectedPrice=CashPricePaid+Gain/LossinFuturesPosition
+[Commission/lbs purchased]
ExpectedPrice=FuturesPricewhenHedgeisLifted+Basis
whenHedgeisLifted+[Commission/lbs purchased]
Forourexample,wewillignorecommission
HedgingExamples
Whatdoesthelonghedgerexpecttopayforthefeeders?
ExpectedPrice=
FuturesPricewhenHedgeisLifted+BasiswhenHedgeisLifted
Howtopredict?
Simplestistousefuturesatthetimethehedgeis
placed
Canconsiderseasonalpatterns,analysts’predictions,
etc.
HedgingExamples
Whatdoesthelonghedgerexpecttopayforthefeeders?
ExpectedPrice=
FuturesPricewhenHedgeisLifted+BasiswhenHedgeisLifted
Howtopredict?
Simplestistouseaseasonalaverage.Forexample,the
calendarweekyouplantoliftthehedge.
Regionalbasischartsareavailableatnocharge
Themorespecifictoyouroperation,thebetter
Thinkaboutwhatinformationyoucancollect
HedgingExamples
Whatdoesthelonghedgerexpecttopayforthefeeders?
ExpectedPrice=
FuturesPricewhenHedgeisLifted+BasiswhenHedgeisLifted
Inourexample…let’susecurrentfuturesandanexpectedbasisof
+$2.00:
ExpectedPrice= $147+(+$2.00)=$149
Example:LongFeederCattleHedgebyaCattleFeeder
Time CashFeederCattle FeederCattleFutures Basis
Action
Priceper
cwt
Position Action
Priceper
cwt
Position
January18,
2018
Planningto
place
feeder
cattlein
March.
$146 Short
BuyMarch
feeder
cattle
futures
contracts
$147 Long Ŋ$1.00
March15,
2018
Purchase
feeder
cattle
$148 Long
SellMarch
feeder
cattle
futures
contracts
$141 Short +7.00
Net
Example:LongFeederCattleHedgebyaCattleFeeder
Time CashFeederCattle FeederCattleFutures Basis
Action
Priceper
cwt
Position Action
Priceper
cwt
Position
January18,
2018
Planningto
place
feeder
cattlein
March.
$146 Short
BuyMarch
feeder
cattle
futures
contracts
$147 Long Ŋ$1.00
March15,
2018
Purchase
feeder
cattle
$148 Long
SellMarch
feeder
cattle
futures
contracts
$141 Short +7.00
Net $148 None Ŋ$6.00 None
NetPricePaid per
cwt
Basis
Expected $149 +$2.00
Actual $154 +$7.00
Error
NetPricePaid per
cwt
Basis
Expected $149 +$2.00
Actual $154 +$7.00
Error Ŋ$5.00 Ŋ$5.00
Basispredictionwaslow,actualbasiswasmorepositivethanexpected
Thelonghedgerpaidahigherthanexpectedprice
Abilitytopredictbasisdeterminesabilitytopredictnetprice
HedgingConcepts:Basis
StrongBasis
Cashishigher,relativeto
futures
Indicatesahigherlocaldemand
and/orlowerlocalsupplyofthe
cashcommodity
WeakBasis
Cashislower,relativeto
futures
Indicatesalowerlocaldemand
and/orhigherlocalsupplyof
thecashcommodity
StrongerBasis Basis
+$0.05
$0.00
Ŋ$0.05
Ŋ$0.15
Ŋ$0.25
Ŋ$0.30
Ŋ$0.35 WeakerBasis
HedgingConcepts:Basis
StrongerBasisThanExpected
Shorthedgersbenefit
Longhedgersfareworse
WeakBasisThanExpected
Shorthedgersfareworse
Longhedgersbenefit
Didthehedgework?
Howdoyoudetermineifthehedgewaseffective?
Temptingtolookatthecashpricewithouthedging:$148vsnet
pricedpaidwiththehedge:$154
Relevanttothebottomlinebutnotawaytoevaluatethehedge
Compareexpectedpricetonetpricepaid:
$149vs.$154
Notgreat,inthiscase…
Youshouldbecomfortablewiththereturnsfromtheexpected
price
Achievingtheexpectedpriceisthegoalofthehedge…evenifit
meansgivinguppotentialcashgains
HedgingConcepts:Options
Afuturespositionisanobligation
Youcanalsobuyorselloptionsonfuturescontracts
Anoptionistherightbutnotobligationtotakeacertainfutures
positionwithinacertaintime
PutOption—theoptiontotakeashortpositioninafutures
contractataspecifiedprice
duringacertaintime
CallOption—theoptiontotakealongpositioninafutures
contractataspecifiedpriceduringacertaintime
HedgingConcepts:Options
Anoptionisdescribedbyafewthings:
Strikeprice—Priceoftheunderlyingfuturescontractatwhichthe
holdercanestablishafuturesposition
Premium—amountthatapersonpaysforanoption(ortheamountfor
whichthesellersellsanoption);quotedinpriceperunit
Put/Call—whatpositiontheholderhasarighttoestablish
HedgingConcepts:Options
Afewnotes…
Brokersdifferinhandlingoptionfees.Somechargetwofeesup
front.SomechargeonefeeandthenanotherIFtheoptionis
exercised
Theholderofanoptioncanalsosimplysellitback.Theresultis
notthesameasexercisingbutitisthe
sameidea.
Asfuturesmovesintheholder’sfavorthepremiumwillincrease
anditcanbesoldbackatahigherpricethanitwaspurchased
for
Optionsfordeliverablecontracts(likeLiveCattle)expireatthe
BEGINNINGofexpirationmonth.Cashsettledoptionsexpireat
theexpirationofthe
contract
HedgingConcepts:Options
Understandingbasisisstillimportant,justaswhenhedgingwith
futures
Optionseliminateundesirablepricevariabilitybutallowfor
beneficialvariability
Sellersofthecashcommoditycanbenefitfromrisingprices
Buyersofthecashcommoditycanbenefitfromfallingprices
Youpayforthisconvenience
Whenahedgerbuysanoption,someoneoutinthemarketsold
thatoption…justlikewithfuturescontracts,riskistransferred
KƉƚŝŽŶƐdžĂŵƉůĞ
OptionExample:UsingaPutOptionto
ManagethePriceRiskofSellingMarketHogs
StrikePrice=$49.000/cwt
Premium=$4.625/cwt
ThesepricesareontheDecembercontractfrom8/13/18
Remember…thismeansanoptionon1contractwillcost$1,850
Onecontractwillcoveraround140markethogs
Putoptionstocoverapproximately1,000head=$12,950
OptionExample:UsingaPutOptionto
ManagethePriceRiskofSellingMarketHogs
StrikePrice=$49.000/cwt
Premium=$4.625/cwt
Aputgivestherighttosellatthestrikepriceand,ifoffsetbya
cashposition,willsetanapproximatepricefloor
ApproximatePriceFloor=Strike–Premium+ExpectedBasis
Let’suseŊ$3asanexpectedbasis
ApproximatePriceFloor
=$49Ŋ$4.625+(Ŋ$3)=$41.375
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$46.00 $49.00 $0.00 $4.625 Ŋ$4.63 $41.375 Ŋ3.00
StrikePrice=$49/cwt
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$45.00 $48.00 $1.00 $4.625 Ŋ$3.63 $41.375 Ŋ3.00
$46.00 $49.00 $0.00 $4.625 Ŋ$4.63 $41.375 Ŋ3.00
StrikePrice=$49/cwt
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$38.00 $41.00 $8.00 $4.625 $3.375 $41.375 Ŋ3.00
$41.38 $44.38 $4.63 $4.625 $0.00 $41.375 Ŋ3.00
$45.00 $48.00 $1.00 $4.625 Ŋ$3.625 $41.375 Ŋ3.00
$46.00 $49.00 $0.00 $4.625 Ŋ$4.625 $41.375 Ŋ3.00
StrikePrice=$49/cwt
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$38.00 $41.00 $8.00 $4.625 $3.375 $41.375 Ŋ3.00
$41.38 $44.38 $4.63 $4.625 $0.000 $41.375 Ŋ3.00
$45.00 $48.00 $1.00 $4.625 Ŋ$3.625 $41.375 Ŋ3.00
$46.00 $49.00 $0.00 $4.625 Ŋ$4.625 $41.375 Ŋ3.00
$47.00 $50.00 $0.00 $4.625 Ŋ$4.625 $42.375 Ŋ3.00
$48.00 $51.00 $0.00 $4.625 Ŋ$4.625 $43.375 Ŋ3.00
StrikePrice=$49/cwt
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$38.00 $41.00 $8.00 $4.625 $3.375 $41.375 Ŋ3.00
$41.38 $44.38 $4.63 $4.625 $0.000 $41.375 Ŋ3.00
$45.00 $48.00 $1.00 $4.625 Ŋ$3.625 $41.375 Ŋ3.00
$46.00 $49.00 $0.00 $4.625 Ŋ$4.625 $41.375 Ŋ3.00
$47.00 $50.00 $0.00 $4.625 Ŋ$4.625 $42.375 Ŋ3.00
$48.00 $51.00 $0.00 $4.625 Ŋ$4.625 $43.375 Ŋ3.00
StrikePrice=$49/cwt
PutOptiontoManagePriceRisk ofSellingMarketHogs
CashPrice
atSale
($/cwt)
FuturesPrice
atSale
($/cwt)
ValueoftheOption
($/cwt)
Premium
($/cwt)
NetImpact
($/cwt)
EffectivePrice
Received
($/cwt)
Basis
($/cwt)
$38.00 $41.00 $8.00 $4.625 $3.375 $41.375 Ŋ3.00
$41.375 $44.375 $4.625 $4.625 $0.00 $41.375 Ŋ3.00
$45.00 $48.00 $1.00 $4.625 Ŋ$3.625 $41.375 Ŋ3.00
$46.00 $49.00 $0.00 $4.625 Ŋ$4.625 $41.375 Ŋ3.00
$47.00 $50.00 $0.00 $4.625 Ŋ$4.625 $42.375 Ŋ3.00
$48.00 $51.00 $0.00 $4.625 Ŋ$4.625 $43.375 Ŋ3.00
$38.00 $42.00 $7.00 $4.625 $2.375 $40.375 Ŋ4.00
StrikePrice=$49/cwt
HedgingConcepts:Options
Onceyoupayapremium,itisgoneforever
Thenegativeimpactonsellingpricewillneverbemorethanthe
premium
Ifpricesmoveinyourfavoryoucancapturesomeoftheupside
riskinthecashmarket
Ifpricesmoveagainstyou,apricefloorisestablished,
subjectto
basisrisk
HedgingConcepts:Options
Acalloptionistheoppositeofaput
Itestablishesanapproximatepriceceiling
ApproximatePriceCeiling=
StrikePrice+Premium+ExpectedBasis
Youareprotectedagainstrisingpricesandcanstillpartially
benefitfromdecliningprices,subjecttobasisrisk
Youcanalsoselloptionsback
insteadofexercisingthem.The
conceptsremainthethesame.
HedgingConcepts:Basis
Whenusingfuturesandoptionstohedge,basismatters
Really,onlybasismatters
Howtodetermineabasisprojection?
3Ŋyearaveragesarereadilyavailable—thisisagoodstarting
point
CooperativeExtensionservicesthroughuniversities
BeefBasis
PrivateFirms
HedgingConcepts:Basis
Worktogetabasistailoredtoyouroperation
Geography
Type/qualityofanimals
Seasonalpatterns
Reliablecashpriceswhenyoudon’tsell(ormaybewhenthereis
notrade)
Overtime,keepingyourownrecordscanhelp
Usinghistoricalbasis—considertherangeaswellasaverage
ƌŽƐƐ,ĞĚŐŝŶŐ
Howoppositeandhowequal?
Timing
Choosingacontractmonth
Matchyoursellingorbuyingtimewindow
Consideropeninterestandvolume
Basis
SizeofPosition
Getascloseaspossibletointendedpurchaseorsalevolumeaspossible
Noexactmatch
Overhedged:futuresposition>cashposition,youarespeculatinginthe
futuresmarket
Underhedged:futuresposition<cashposition,youarespeculatingin
thecashmarket
Howoppositeandhowequal?
ContractMatch
Manylivestockhedgesarecrosshedges,inthatlivestockdonotexactly
matchthecontractspecifications
Closecrosshedges
UsingtheFeederCattleContracttohedgeheifers
UsingLiveCattleContracttohedgebeefsteersnotbornintheUS
Crosshedgesabitfartherfromthecontracts
UsingLiveCattleContracttohedgelivedairybreedsteers/heifers
UsingtheFeederCattleContracttohedge500lb weanedcalves
Justlikehedges,crosshedgesworkifcashandfuturesmovetogether
inapredictableway
Seasonalpatternscandifferwithcrosshedges
Ifthecrosshedgeisnotaclosematch,a1to1hedgeratiomightnotbe
thebeststrategy
Example:BasisforCrossHedges
Technically,hedgingfeeder
heifersisacrosshedge
Avg monthlybasisbetween
Ŋ$5/cwtand$1/cwt
Standarddeviationsof
monthlybasisbetween
$2/cwtand$8/cwt
Example:BasisforCrossHedges
Astheweightmoves
outsidecontractspecs,
basisvariabilitychanges
Avg monthlybasisbetween
$11/cwtand$31/cwt
Standarddeviationsof
monthlybasisbetween
$14/cwtand$26/cwt
Cashmarketsfor6Ŋ7and4Ŋ
5weightfeedersareclosely
relatedbutnotidentical
Example:BasisforCrossHedges
Cashmarketsfor6Ŋ7and4Ŋ
5weightfeedersareclosely
relatedbutnotidentical
Similarseasonalpatterns
buttypicallybigger
movementsinthebasisfor
lightercalves
HedgingConcepts:CostsofHedging
BrokerFees
NFAfees($0.02pertransaction)
Opportunitycostofcapitalinthemarginaccount
Opportunitycostofresearching/projectingbasisand
determiningstrategies
HedgingConcepts:MarginAccounts
Toopenafuturesposition,youmustdepositanamountequalto
theinitialmarginneededforeachcontracttimesthetotal
numberofcontractstraded
Thereisamaintenancemarginlevelforeverycontract.Thiscan
varyamongbrokers.
Thebalanceofyourbrokeraccountisthemoneydeposited
plus
theequityinyourposition(s)
Ifthisbalanceisbelowmaintenancemarginlevel,youmust
depositcashtobringthebalanceuptoinitialmarginlevel
HedgingConcepts:MarginAccounts
Marginaccountsrequiresubstantialcapital
MarginforoneCMEFeederCattleContractis$2,800
$8,400margintohedgeabout200head(800lb animals)
Capitalisrequiredtobeheldaslongasyourpositionisopen
FuturesExchange
(e.g.,CME)
FuturesClearing
Merchant
(FCM)
Broker
FuturesMarket
Traders
ShortHedgers
LongHedgers
Speculators
MechanicsofTradingFuturesandOptions
Anyonewishingtotradefuturesoroptionswillworkwithabroker.Abrokeris
licensedtoplacetradeswithanFCM.FCMshaveaseatonagivenfutures
exchangeandhavetherighttotradeonthatexchange.It istheFCMthat
executesthetradeswithanexchange.
ItispossiblethatthebrokerandFCMare
thesameorganization.
Therelationshipwiththebrokermaybecompletelyelectronic,overŊtheŊphone,
inŊperson,orsomecombination.
Givethebroker
instructionstoliquidate
theposition.Thiscanbe
basedonsome
predeterminedruleora
spontaneousdecision.
Thegain/lossforthetrade
iscredited/debitedfrom
yourbrokeraccount.
Note:Foroptions,this
stepmightnotbe
necessary.
Maintainmargin
account
Iftheequityin
theaccountfalls
below
maintenance
margin,youmust
replenishitupto
initialmargin
level
Givethetrade
ordertothe
broker,whowill
havethetrade
executed
Thiscanbe
electronicallyor
byphone,
dependingon
thebroker
Findabroker
andestablishan
account
Depositatleast
theinitial
margin
requirementsin
theaccount
MechanicsofTradingFuturesandOptions
Youmustpayabrokerfeeforeverytrade.Feesaregenerallyintherangeof$5to
$40.Higherfeescomewithmoreaccesstothebrokerforadviceandguidance.
Lowerfeesareforelectronicplatformswherethetradersimplypointsandclicks
toaccomplishtheabovesteps.Choosing
abrokerisanimportantdecision.Put
sometimeandresearchintoit.
HedgingConcepts
Aproducerishedging(orhedged)ifandonlyifshehasequal
andoppositepositionsincashandfutures
Takingcaretomatchcontractsizeandcashpositionisimportant
Anydeviationfromthisinvolvesspeculatingineitherthecashor
futuresmarket
Ahedgetradesflatpricerisk
forbasisrisk
Understandingyourownbasisisessentialforaneffective
hedgingstrategy
HedgingConcepts
Hedgingisonepossibleriskmanagementtoolthatcanfitintoa
producer’sbigpictureplan…butisnotasubstituteforgood
management
Producersshouldevaluatetheirfinancialsituationandtheirown
personalitiesthendecidewhetherhedgingmakessense
Ingeneral,aproducercanhedgetotargetanacceptablereturn
Knowingperunitproductioncostsisnecessaryforthistowork
HedgingConcepts
Ifyouarehappyenoughwithatargetreturntohedgeit,thenbe
happytotakeit…evenifyourhedgeinayearmeansyougave
uppotentialcashmarketgains
Ahedgeiseffectiveifitallowsyoutoachievethistarget
Whatwehavediscussedtodayisbasic,disciplinedhedgingfor
managingrisk
Manyproducersusemorecomplexstrategiesthatinvolve
markettimingandcombinationsofinstruments
HedgingConcepts
Whatwehavediscussedtodayisbasic,disciplinedhedgingfor
managinglivestockpricerisk
Planhowusingfuturesoroptionswillmeshwithotherpricerisk
strategieslikeinsurance,cashcontracts,etc.
Don’tforgetotherrisks
Feedprice
Fuelprice
Weather
Disease
Resources
Agmanager.info
https://www.agmanager.info/grainŊmarketing/publications
https://www.agmanager.info/grainŊmarketing/publications#priceŊriskŊ
publications
https://www.agmanager.info/livestockŊmeat/marketingŊextensionŊ
bulletins/priceŊrisk
IowaStateExtensionandOutreach
https://www.extension.iastate.edu/agdm/ldmarkets.html
https://www.extension.iastate.edu/agdm/cdmarkets.html
CMEGrouphasexcellenteducationalmaterialsatnocharge
www.cmegroup.com
Resources
BeefBasis
MixofnoŊchargeandfeeŊbasedmaterialsanddata
https://beefbasis.com/
LivestockMarketingInformationCenter(LMIC)
www.lmic.info
Marketpricereportdata,productiondata
Livestockandmeatdata
Accesstomostusefuldatarequiresamembership
BrianK.Coffey
AssistantProfessor
DepartmentofAgriculturalEconomics
KansasStateUniversity
785Ŋ532Ŋ5033
[email protected]
@BrianKCoffey
^ƵƉƉůĞŵĞŶƚĂů^ůŝĚĞƐ
HedgingConcepts:MarginCalls
Asanexampleofhowmargincallswork,considerapositionof
onefeedercattlecontract
InitialMargin=minimumrequiredtoopentheposition=$2,800
MaintenanceMargin=amountatwhichamargincallisinitiated
=$2,800(initialandmaintenancecanbedifferent)
Ashorthedgersells
acontractatthecurrentfuturespriceof
$145/cwt
HedgingConcepts:MarginCalls
Date Cash
Balance
Futures
Price
Position
Equity
Net
Account
Value
MarginCall
7/30 $2,800 $145 $0 $2,800
7/31
8/1
8/2
8/3
8/4
InitialRequirement=$2,800 Position=short@$145
MaintenanceMargin=$2,800
HedgingConcepts:MarginCalls
Date Cash
Balance
Futures
Price
Position
Equity
NetAccount
Value
MarginCall?
7/30 $2,800 $145 $0 $2,800
7/31 $2,800 $143 $1,000 $3,800 No
8/1 $2,800 $144 $500 $3,300 No
8/2
8/3
InitialRequirement=$2,800 Position=short@$145
MaintenanceMargin=$2,800
HedgingConcepts:MarginCalls
Date Cash
Balance
Futures
Price
Position
Equity
NetAccount
Value
MarginCall?
7/30 $2,800 $145 $0 $2,800
7/31 $2,800 $143 $1,000 $3,800 No
8/1 $2,800 $144 $500 $3,300 No
8/2 $2,800 $147 Ŋ$1,000 $1,800 Yes,$1,000—must
restorenetacct
valuetoinitial level
8/3
InitialRequirement=$2,800 Position=short@$145
MaintenanceMargin=$2,800
HedgingConcepts:MarginCalls
Date Cash
Balance
Futures
Price
Position
Equity
NetAccount
Value
MarginCall?
7/30 $2,800 $145 $0 $2,800
7/31 $2,800 $143 $1,000 $3,800 No
8/1 $2,800 $144 $500 $3,300 No
8/2 $2,800 $147 Ŋ$1,000 $1,800 Yes,$1,000—must
restorenetacct
valuetoinitial level
8/3 $3,800 $147 Ŋ$1,000 $2,800 No
InitialRequirement=$2,800 Position=short@$145
MaintenanceMargin=$2,800