Marketing Tactics in Volatile Times Matthew Diersen, Ph.D. Department of Economics South Dakota State University May 6 & 8, 2008

2 Outline General observations Volatility discussion Wheat strategies Synthetic puts Cattle strategies Timing price & risk

3 What Has Changed Disruptions have occurred Question rural legends about marketing Ability to price like never before Fundamental drivers Speculative forces Need to deal with credible partners

4 Marketing Plans One plan per enterprise Get a handle on the big picture High stakes mean: more to keep track of more room for error Evaluation more important than ever Understand what did not work Contingency plans important

5 Pricing Know what you are trying to beat Lock in high enough up-front profit Pull trigger after prices move favorably Reduce transaction costs Done with: 1.Handshakes to forward contracts 2.Futures contracts

6 Protection Already realize profits Want to get higher returns Want to guard against wrecks Cover yourself prudently Done with: 1.Options contracts 2.Insurance contracts

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8 Buying Options A put option is the right, but not the obligation, to sell a futures contract Cost is paid up front $/cwt quoted times the cwt of the contract Premium made up of following parts Intrinsic value (strike-futures) Time value (interest) Volatility in futures price (biggest driver today) A call option is the right, but not the obligation, to buy a futures contract

9 Money Talk In-the-money put Strike price is above the futures price Implies a positive intrinsic value Will cost the most At-the-money put Strike price is near the futures price May be closest-to the futures price Out-of-the-money put Strike price is below the futures price

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14 Wheat Tactics

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16 Wheat Tactics for Today Winter wheat Know your insurance Cover sales by buying calls Buy put options Spring wheat Forward contract prudent % Buy put options Sell futures & buy OTM calls

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18 Crop Insurance Often buy Crop Revenue Coverage (CRC) Futures have exceeded upper limit Hedge losses could greatly exceed indemnity Can be managed with call options Risk Calculator Available at What level can be prudently hedged?

19 Pricing and Protecting Wheat Rely heavily on KC, MPLS markets Better hedging performance Work with lender on margin account Margin costs are higher Worst-case returns likely low given: Low loan rate Increased production costs Inadequate insurance Prices have some support from corn (feed)

20 Basis Risk & Storage Highlights local conditions Transportation concerns Price convergence still probable Crop insurance of no help Weigh basis improvement against carry Tough to store with inverted markets Monitor interest opportunity cost Some research supports some speculative storage behavior

21 Cover by Buying Calls Before: forward contracted winter wheat for $9.00 Now: buy KC Sep $9.00 call for $0.75 Contract Premium /- Basis n/a = Floor 8.25 * No ceiling * Now: sell MPLS wheat futures for $9.00 Now: buy MPLS Sep $11.00 call for $0.40 Futures Premium /- Basis = Floor 7.80 * No ceiling *

22 Current Prices

23 Feeder Cattle Tactics

24 CHANGE IN BEEF COW NUMBERS JANUARY 1, 2007 TO JANUARY 1, 2008 (1000 Head) Alaska Hawaii US Total Livestock Marketing Information Center Data Source: USDA/NASS

25 Feeder Cattle Tactics for Today Sell futures or forward contract Know the relevant basis Buy put options Buy Livestock Risk Protection Build wide fences

26 Feeder Cattle Contracts Contract is for 50,000 pounds of steers Contract months: January, March, April, May, August, September, October, and November Futures settle on the last Thursday of the contract month (except November) Cash settled to the CME Feeder Cattle Index lbs Medium and Large #1, #1-2

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30 Livestock Marketing Information Center

31 Livestock Marketing Information Center Seasonal Price Increase High Corn Volatility

32 Buy a Put Oct Feeder Cattle trade at $110: OutAtIn Strike Premium /- Basis = Floor

33 Current Prices

34 LRP vs. Other Tools LRP has Price Adjustment Factors Fixed percent up front and at settlement For Steer calves: 110% Forward contracts likely give the best basis Synthetic put strategies need brokers help LPR designed for spot sales in final 30 days of coverage (transferable on earlier sales)

35 Typical Marketing Plan Cow-calf producer with 140 steers & 100 heifers to sell on October 15, 2008 Buy 2 Oct puts (200 head), 108 strike, for $3.00 per cwt. or better Buy LRP on 40 steers if floor exceeds $115 and cost is $4.00 per cwt. or better Sell 1 Oct futures (100 head) if $115 or better (assume $10 cwt. basis)

36 For More Information Commodity Exchanges CME, MGEX, KCBOT USDAs Risk Management Agency SDSU Department of Economics Extension / Current Market Analysis FS 929 – Writing a Commodity Marketing Plan ExEx 5055 – How to Capture High Calf Prices

37 Some Thoughts Put all your eggs in one basket, then watch that basket. – Mark Twain Active risk management means doing things 1) when prices are high, 2) when volatility is low, and 3) before its too late

Any Questions?