Why puts matter in cattle marketing

What happened

In recent weeks, the cattle complex (both live and feeders futures) has made a major turn from a continuous price uptrend to a sharp correction, and now, a change in trend. Strong demand and tight supplies this fall suggested the futures market may trade up to $200. And it came close with the high in April live cattle at $199.82 posted on September 15. However, in a mere nine weeks, futures lost more than $29. It took 10 months for April futures to gain $33 before peaking. January feeder cattle have a similar story, topping at just over $268 in mid-September only to lose over $56. Is there a way to prepare for such a sharp downturn?

Why this is important

Tight supplies of cattle were the backdrop to a longer-term price uptrend. Recently, money has been flowing out of cattle futures due to large managed fund moves and meat packers reducing kills to make up for tight margins. This has all pressured prices. Managed money that was buying on tight supply had switched its mindset when it became clear that demand from consumers showed signs of waning. A weakening economy, higher interest rates, and increasing consumer debt are elements of the bigger fundamental mix of variables that may have changed traders’ perspectives.

What can you do?

Cattle producers have marketing options. Forward selling (contracting with a packer) is one option. The issue many have using this tool is that, if prices continue to climb, it feels like you have made a mistake. When you should be selling more, you don’t because you don’t want to compound the problem of already having sold at a lower price. Hedging (selling) futures offers flexibility in the sense you don’t have to make a delivery and you can exit at any time. However, the same basic issue exists – when you should be selling more, it often doesn’t happen. Margin requirement is also a consideration. A tool, however, that should be considered is the purchase of a put option.

A put provides the owner the right (not the obligation) to sell futures. Puts are traded at the Chicago Mercantile Exchange (CME Group) and need to be purchased (traded) through a licensed broker. You pay a premium for a level of price protection, called a strike price. When purchased, your risk is premium paid plus commission and fees. The price of your physical product (in this case cattle) is not locked and can increase in value, should futures continue to trend upward. If prices decline, the put can gain value and offset declines in the cash market. It is flexible in the sense you can buy and sell when you choose or, if desired, you can exercise (convert) it into a short futures contract assigned at your strike price.

The bottom line is that put options have a place and time. It is difficult to pick a price top, especially when prices are trending higher. Price direction can change rapidly. An example is the corn market this past summer, when December futures rallied from near $5.00 to over $6.25 on hot and dry conditions in June, only to pivot and sell off to under $5.00 in nine trading sessions. One day you feel you should be bullish and have not made any sales. The next day you feel you should be bearish and have sold more. Using puts in an up-trending market can make sense. Learn about them – their risks and rewards – and consider how they might work for your operation. Keep your toolbox of marketing strategies ready. A put is but one tool in your toolbox. Puts can provide peace of mind, knowing you have a price floor, while at the same time, knowing your product can still increase in value.

Editor's Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.

Disclaimer: The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.

About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.