A straight hedge may not work. An at-the-money put option is probably too high. Forward pricing with the packer is likely a loss. So cattle feeder Robby Kirkland often relies on multiple strategies that utilize two or more marketing tools to help corral a profit.

Kirkland and his father, Perry, operate Kirkland Feedyard Inc. in Vega, TX. Whether it's company-owned cattle or a customer's pens that need marketing, he tries to stay a step or two ahead of what's currently on the futures board and what fed steers or heifers might bring from the packer.

“It's a shame you have to play the futures market to make it work, but it's come to that,” Kirkland says. He notes outside forces like trading funds, the foreign-market situation, and tight feeder cattle supplies have created too many variables that impact prices.

George Enloe, co-owner of Amarillo (TX) Brokerage Co., adds, “Feeding margins have been worse for longer than I can remember. If you buy feeder cattle that show a $50 to $80/head loss when they finish, you absolutely cannot hedge.”

Enloe's company offers a program to enable feeding customers, as well as cow-calf and stocker operators, to consider numerous marketing strategies to find one that best fits the risk-management level they seek. But even those plans, which range from a simple put-option insurance policy to a sophisticated system using futures and options, may not pull out a profit with today's margins.

Kirkland's creative marketing often involves what he terms “legging into a synthetic hedge,” which actually isn't as complex as it sounds. But it requires constant monitoring of the Chicago Mercantile Exchange futures price for a given contract month.

He basically sets his sights on a particular hedge price. To achieve that price, he's often forced to buy a call option and then lock in the futures price if and when the market moves upward. He “legs” into it.

“If I want to hedge in a price of $90/cwt. and the market is at $86 for cattle to be delivered in early 2006, I'll look at buying the $90 February call option,” Kirkland says. “I'd try to hold the cost of the call at $1 to $1.50/cwt. Then, when the market rallies up to the $90 level, I'd hedge the cattle and have my calls in place to open the topside back up.”

To protect against the market crashing, he may buy out-of-the-money put options to set a floor.

“The puts are a safety net,” he says. “They keep you from pushing the panic button if the market goes down.”

Kirkland says he normally doesn't get too far out in his marketing.

“I try to stay two contract months out,” he says. “In the summer, when August futures rolled out, I tried to fill December (there are no September or November live cattle futures contracts) for cattle to be delivered then.”

He also works with feeding clients who request help with their risk management.

“We find out what type of risk tolerance a customer may have,” he says. “If the customer wants to limit losses to $50/head, we can do that with futures, options or a combination of both. But we might limit his profit potential to $50 at the same time.”

The level of risk a cattle feeder requires is also considered by Amarillo Brokerage in its Ag EMS (Equity Management Services) program. Enloe notes many of the firm's customers are larger feeding companies. These outfits normally have their own risk management teams who require basic brokerage services.

But Ag EMS enables smaller operators to maintain a disciplined marketing program without spending a lot of time at it.

“It enables producers to concentrate on what they do best — putting pounds on their cattle in the most efficient way possible,” Enloe says.

In a typical program, Enloe and his associates first help the producer or feeder customer analyze his breakeven price for one or more lots of cattle. With that breakeven in place various marketing possibilities are examined using futures and options trading. Up to six different marketing strategies are laid out for the customer to consider.

“We help the customer analyze the various strategies to determine which one best meets his risk management needs,” Enloe says. “Those needs will vary from feeder to feeder, or even from one lot of cattle to another.”

Once the marketing strategy has been selected, the brokerage firm institutes the trade positions. Customers receive a monthly statement detailing how each transaction is performing.

“If we see the opportunity to enhance a position due to changes in market factors, we'll consult with the customer and make any requested changes in the position,” Enloe says.

The cost of the program can vary, but an average producer feeding one to 500 head should expect to pay about $5/head. But, as Enloe emphasized earlier, “Risk management is next to impossible when breakevens are $3 to $7/cwt. over futures and $7 to $11/cwt. over cash.”

A “highly speculative position?”

John Anderson, Mississippi State University livestock marketing economist, says using more complex futures and options strategies to try to wring a higher profit out of the market can be a highly speculative proposition.

“The producer may still think of such strategies in terms of hedging cash fed cattle but, in practice, many of these strategies really amount to trying to make money from speculative positions in the futures market in order to enhance cash market returns,” Anderson says. “There's nothing necessarily wrong with this as long as the producer understands this is likely to actually increase risk rather than reduce it, which is what we expect from a straight hedge.”

He says it's difficult to find any black ink on cattle coming out of the feedyard in early 2006.

“I think the most reasonable strategy is to look for something to minimize potential losses, such as buying a put or setting up a synthetic put, while leaving the upside open,” he says. “I know this isn't a very satisfying solution, but it's a sound strategy from a risk-management perspective.”

Kirkland says his multiple strategies of using a combination of call options and then hedges may not work if the bear market continues.

“We could see more puts used than in the past to protect a price when the market rallies,” he says. “But, again, the type of marketing strategy you use depends on the risk tolerance you have and what you're willing to risk in the market.”

Larry Stalcup is an Amarillo, TX-based writer on cattle marketing and risk management topics.