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

2. Choosing from livestock risk management tactics

3. 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/ http://www.rma.usda.gov/livestock/  Factsheets  Premium calculator  http://www.extension.iastate.edu/agdm/ldcostsreturns.html http://www.extension.iastate.edu/agdm/ldcostsreturns.html

4. 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

5. 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

6. 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)

7. Comparison of Livestock Risk Protection Policies… http://www.extension.iastate.edu/agdm/livestock/pdf/b1-50.pdf

8. LRP Example… CoverageExpectedCoverage Cost per LengthPrice Level %cwt 13 weeks$143.30$135.4794.54%$0.670 13 weeks$143.30$125.4787.56%$0.095 17 weeks$145.04$134.4492.69%$0.527 17 weeks$145.04$128.4488.56%$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_r eports/main.aspx

9. 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

10. 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, you’re locked in

11. 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

12. 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

13. LGM Guarantees for Hogs  Farrow to Finish  Gross margin per hog t = 2.6*0.74*Lean Hog Price t - 12 bu. * Corn Price t-3 - (138.55 lb./2000 lb.) * SoyMeal Price t-3  Finishing  Gross margin per hog t = 2.6*0.74*Lean Hog Price t - 9 bu. * Corn Price t-2 -(82 lb./2000 lb.) * SoyMeal Price t-2  SEW  Gross margin per hog t = 2.6*0.74*Lean Hog Price t – 9.05 bu. * Corn Price t-2 -(91 lb./2000 lb.) * SoyMeal Price t-2

14. LGM Guarantees for Cattle  Yearlings  Gross margin per head t = 12.5*Live Cattle Price t – 7.5*Feeder Cattle Price t-5 - 50 bu. * Corn Price t-2  Calves  Gross margin per head t = 11.5*Live Cattle Price t – 5.5*Feeder Cattle Price t-8 - 52 bu. * Corn Price t-4

15. 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

16. DecJanFebMarApr 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…

17. 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…

18. 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 cattle t = (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 yearlings example…

19. 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

20. 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.

21. 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

22. Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/ Spring2015/