In a world where categories are demographed, sub-demographed, psychographed and niched to death, you'd think selecting the best risk management tools would get easier. That's not necessarily so.
"Risk management is a broad topic and it's becoming broader," says Ted Schroeder, agricultural economics professor at Kansas State University. "It used to be that we talked about price risk management and production risk management, but both have grown into multifaceted issues with a variety of evolving tools to help manage risk."
Schroeder says keeping up to speed on basic risk management practices is no small task itself. And, he adds, there are new risk management tools right around the corner that will offer more alternatives than we previously imagined.
Basics No matter how many risk management tools crop up, they all start with the basics. There are four basic sources of risk when it comes to feeding cattle, Jose Pena, a Texas A&M Extension economist in Uvalde, TX, says. They are: 1) price, 2) death, 3) performance and 4) weather. Making sure your customers understand them will help them make realistic risk management decisions.
"What you do with all these factors is 'safe side' your risk and in your analysis, have a best estimate of what each factor might be and how it will affect you or your customer's desired goals," Pena says. "For example, with price risk management, you determine an 'in' price and 'out' price. Then, based on experience and quantitative information, determine what effects each of the risk factors will affect what you need to make a profit.
"Things that will have an effect on determining out prices include rate of gain, cost of gain, average death loss, genetics and the type of market where the cattle will be sold."
Manage What You Control Along the same lines, Schroeder says it's important to understand there is no single, best strategy for managing price risk, or any risk for that matter.
"The whole idea of economic risk management is to reduce the risk of returns going in the opposite direction you desire," he says. "It's best to manage things that can be controlled. That starts with genetics, information management, cattle management and basic production practices."
Once these are in place, Schroeder says to determine markets where you can best match the value of the cattle being marketed.
That's one area where alliances come in. Schroeder says while alliances don't offer profit guarantees, they can significantly increase the amount of information producers have about cattle performance and quality. Generally, risk can only be reduced by giving up potential returns. However, increased information helps producers better target cattle management and marketing. This potentially reduces risk, while increasing profit.
Customers Must Understand It won't matter how good your risk management skills may be unless customers understand the recommended practices, their responsibility and your responsibility, Pena says.
"Be willing to satisfy all variables with good communications," he says. "For example, tell customers you've got enough grain forward contracted for a specific time period so the cost of gain estimate will be as accurate as it can be. Make sure they understand how you've arrived at your loss estimates. A feedyard manager's bedside manner will go a long way to establish credibility, especially to customers new at using risk management tools."
Local Extension service offices offer risk management publications that cover the topic from the most basic contracts to the most advanced.
The Future Making sure customers know the basics will help when new risk management tools are launched.
Schroeder says new tools for those with strong needs to reduce risk, such as highly-leveraged operations, are on the way. Referred to as complete cost revenue management insurance, the practices will allow cattle owners to better secure production and price variables.
As with all risk management alternatives, this insurance will be more desirable and useful for certain circumstances than others. The key is to understand the risk management opportunities being offered and to be realistic about the amount of risk you face and can afford.
Despite the advent of new tools, producers and feeders will still be subject to global price movements, he says. That reality simply increases the need for a solid risk management plan.
More information to help get customers started using risk management is available from Extension services, independent brokers and these Web sites:
Kansas State University:
Oklahoma State University:
Texas A&M University:
Texas Cattle Feeders Association:
It is critical for customers to understand the tools used for managing risk. A continual review of terms can be helpful to those who use risk management infrequently. The following checklist offers sample marketing terms defined by Texas A&M University and Kansas State University.
Cash Market Basis - the difference between a cash price and a futures price of a commodity on a given futures exchange. Calculated as: Basis = cash price minus futures price.
Basis contract - an agreement between a producer and feedlot that specifies the cash price upon future delivery as a fixed amount above or below the futures price, fixing the basis.
Deferred payment - a delayed payment on the sale of a commodity from the producer to the buyer, with the price to be determined later.
Forward contract - a contract for the cash sale of grain at a sp ecified price for future delivery.
Minimum price contract - a contract that establishes a minimum, or floor, sale price and allows the seller to capture a higher price if prices rise.
Futures Market Carry spread - when the nearest futures month is trading at lower prices than a distant futures month.
Carrying charge - a futures market condition in which distant futures contracts are trading at higher levels than nearby contracts and above cash price offers. Often indicate a surplus.
Clearing house - an agency of the futures exchange responsible for matching purchases and sales.
Delivery - the settlement of a futures contr act by receipt of the actual commodity.
Delivery month - the specified month in which delivery can be made under the futures contract.
Making Trades Market order - instructs the broker to immediately execute an order at the current price in the pit.
Limited order - an order that has a time or price restriction to its execution. Stop-loss order - an attempt to limit risk by placing a liquidation order if the price moves to a specified level.
Options Call option - gives the buyer the right, but not the obligation, to purchase an underlying futures contract at the strike price on or before the expiration date of the option.
Exercising options - initiated by the buyer of an option when he takes ownership of the underlying futures contract at a specified price. The seller is obligated to take the transaction.
Expiration date - the day when the option holder loses the right to exercise the option.
Offset - the liquidation of an options contract position.
Put option - gives the buyer the right, not the obligation, to sell the underlying futures contract at the strike price on or before the expiration date.
Strike price - the price at which the option holder may ee underlying futures contract.