Being 100% hedged isn't just for the big boys. Small feedyards can also protect themselves against market slumps through creative marketing.

Dick Mercer, Kearney, NE, and his family aren't intimidated by the Chicago Mercantile Exchange (CME). Their central Nebraska 3,000-head feedyard likes to take advantage of CME marketing opportunities.

Until this summer, the fed-cattle market had been good for more than two years, despite some potentially catastrophic situations with BSE. The industry managed to get through the recent BSE case in Texas with no major market plunges. But the Mercers had a plan in place long before that to protect against sudden market shifts.

“We always try to have some sort of protection on our cattle,” says Steve Mercer, Dick's son who looks after much of the marketing for the crop and livestock enterprise. “For the past two to three years, we've seen some good times. There were even some abnormal profits. We used mainly put options to give us some price insurance.”

100% hedged

Now, however, Steve says the operation is 100% hedged using futures contracts.

“We've had to be more conservative in our marketing,” he says. “With what we've had to pay for feeders, we feel a guaranteed, locked-in profit is a better strategy.”

For cattle that went to the packer in early July, $87 June '05 live-cattle futures were sold in mid March. That was for cattle with an $84/cwt. breakeven. They garnered a $25-$30/head profit.

Cattle scheduled for delivery to the packer this fall were hedged with $88 September futures in early summer. Those hedges also covered cattle that had an $84 breakeven. That provided a profit of about $40/head, even if prices head south for one reason or another.

Dick says they're also looking at hedging cattle for delivery next spring at $88 on the April or June '06 contract. As with the other contracts, if there are major shifts in the hedges one way or another, they may be lifted or rolled to take profits or increase price coverage.

“Marketing has always been difficult,” Dick says. “After 50 years of running a feedyard, I wish I had been a better marketer.”

He points out that luck is often as important as strategy.

“In late 2003, we sold about 1,000 finished cattle, delivering them one week before the first BSE case was announced (Dec. 23, 2003),” he says.

Those cattle brought mid- to high-$90s prices. After the BSE announcement, the market took a 20% drop but regained most of its strength in a short time. But, if the Mercer cattle had been ready for delivery on Christmas Eve that year, “bah, hum bug” would have been an understatement.

Steve says those cattle were protected by out-of-the-money put options, so a complete wreck would have been avoided if delivery had been a little later.

“You have to be prepared to handle a volatile market like this,” he says.

A wide view is best

Brock Thompson, a commodity broker/consultant for Tejas Trading Co., Amarillo, TX, agrees. But, he also points out that protecting the fed-cattle risk may involve using other commodity markets along with live cattle futures or options.

“You have to look way out in front at your grain and feeder markets,” says Thompson, whose company partners also own Quality Beef, a Wildorado, TX, custom feedyard. “You might have to look at a ‘crush spread’ (in which feeder cattle futures or options are used along with live cattle futures) to help lower your breakeven costs when they get to the feedyard.”

Thompson stresses that marketing practices have changed in that using a straight hedge and leaving it in place through delivery to the packer may not work as in the past.

“Old-style hedging has gone by the wayside,” Thompson says. “There are a combination of factors involved in deciding when to lift hedges. You have to look at what position commodity funds currently hold, the market fundamentals, and chart technicals to decide where to lift hedges.”

If solid hedges or options pricing aren't feasible, he suggests feeders consider “save-the-farm-puts,” or out-of-the-money put options to provide insurance against a wreck.

Matt Diersen, South Dakota State University Extension economist, says he was encouraged by the market's muted reaction to the June BSE case. Hopefully, it will help remove some levels of risk from the fed-cattle market, he adds.

“There are no magical answers to this market,” he says. “But there are indications the calf crop will be a little larger, so we should have more cattle to go on feed than a year ago. We could see lower feeder-cattle prices, which could improve the competitive situation among feedyards as early as this fall.”

Though there's no easy way to lock in a good price on fed cattle, Diersen says cattle feeders “who are getting squeezed” might consider pricing cattle using futures or a forward contract and then buying an out-of-the-money call option.

“This synthetic put-type of trade enables the feeder to take some money out of the market if it rallies to the upside,” he says.

Thompson says if there's potential to lock in lower corn prices in a volatile grain market, feeders should look at corn futures or options to secure the lower cost corn.

That's the approach the Mercers take. Though they grow corn on their farm, it's a separate marketing entity. They market their corn aggressively — just like their cattle — but buy corn for the feedyard as cheaply as possible.

“We priced most of our corn for feed at about $2.08/bu.,” Steve says, adding that corn sold for grain was marketed in the $2.40-$2.60 range.

Larry Stalcup is a freelance writer based in Amarillo, TX.