Paul Fruendt looks at his withered pastures and wishes he could guarantee when or if the drought will fully end and his stock tanks refilled. But he can’t. However, by using feeder cattle options windows, he can virtually guarantee his overall selling price and whether profit is on the horizon.

Fruendt’s Guthrie, OK, operation consists of about 50% stockers and 50% wheat/sorghum production. He prefers to run cattle to about 800 lbs., but dry conditions likely will force him to sell most of them this spring and into the summer and fall at 600-700 lbs.

He is like far too many Southern Plains producers. Little summer grass and poor small grains grazing last year forced them to either sell stockers earlier than they’d like or cut back on cattle numbers.

Ironically, 2012 saw Fruendt yield a good winter wheat crop, thanks to early-year rainfall. “It was the first good wheat crop I had made in 10 years,” he says. But there was little moisture in the summer, fall and into this year, and wheat pasture prospects grew thin. “We had to hold back on the number of stockers we bought.”

Entering 2013, his numbers were about 50% of normal. Still, those cattle needed risk management. “We put those cattle on wheat pasture last fall,” Fruendt says, “and we decided to go with a put-call window to set a floor price.”

Here’s what he did: “In November, we bought $150/cwt. April feeder cattle puts, then sold April calls at $160. Those cattle will be marketed this spring.”

A Closer Look: Managing Today’s Downside Risk Is Critical

His central Oklahoma region received some needed moisture, but he’s still not sure if he can replace all cattle numbers. “The water situation, with little runoff into our ponds, is still our biggest problem,” he says.

He hopes to be back to 75-80% of normal numbers by August. That will likely involve additional options strategies, a risk management approach that Fruendt is very comfortable using.

“I’ve used options for about 20 years,” he says. “I like to price cattle early. With our dry conditions, we’re probably not going to see a lot of big upside in the market or a major decline. But we will be protected if either situation happens.”

Year-end price rally

Cattle prices rallied as 2012 ended, and feeder prices increased by $10/cwt. or more. That had Fruendt eyeing additional spread opportunities to set a price and keep the cost of price protection low.

The price rally saw August 2013 feeder cattle futures with a floor price in the $160 range in mid-January, a sign of continued drought in much of the country. But after some heavy snows and rainfall that greened up some wheat, August futures slid back to about $152.

The cost of a $152 August put was about $4/cwt. in early March. To offset that high premium price, a window could be set to establish a $162 high by selling an August call for $1.50. That would lower the cost of protection to about $2.50.

If the market pulls sharply back, there is still a $152 floor, less the $2.50 cost. If the market shoots past $162, then the high price would certainly cover any possible margin call that could result.

Bullish outlook

Derrell Peel, Oklahoma State University livestock marketing specialist, remains bullish on prices. “Overall, for the next couple of years, there is little downside risk in this market,” he says. “Our biggest concern remains the drought.”

But that doesn’t mean there won’t be volatility. “Options are good for protecting against a disaster that can take prices down,” he says.

Peel says continued tight cattle supplies are keeping prices propped up. However, a slowdown in beef demand due to high prices will likely set a ceiling.

“Beef production is expected to be off by 4.5-5% in 2013,” Peel says. “But beef demand will likely put a limit on how high markets will go. The question is how high can prices go?”

He says that if the drought subsides, then feeder supplies may get even tighter because producers will start holding back some heifers for replacements. “There should be good profit potential for stocker operators and cow-calf producers – if they have the forage,” he says.

He adds that the 2013 decrease in beef production is expected to be followed by a 2014 decrease of 5% or more. “These two years would represent the largest percentage decrease since the late 1970s,” he says.

Also, he expects per-capita beef consumption to drop 3.5% in 2013. That’s less than the production decrease because beef imports will increase and beef exports will decrease. “Beef consumption may drop more sharply in 2014, with a 5% decrease in per-capita consumption compared to the lower 2013 level,” he says.

These decreases in beef production and consumption almost certainly imply higher wholesale and retail beef prices. “The pressure for higher boxed-beef prices will increase significantly with an expected 4.5% decrease in beef production in the first quarter of 2013.”

Along with continued dry weather in many stocker-producing regions, uncertainty over how much consumers will be willing to pay for beef, as well as negative situations like the lean finely textured beef fiasco, will impact cattle prices through the year. Glynn Tonsor, Kansas State University livestock marketing specialist, says that will continue to require good risk management among stocker and cow-calf operators.

 

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“Ultimately, segments of the industry that are most comfortable with this increasingly complex, uncertain and dynamic business environment will be those who stay the course, reinvest and expand their operations,” he says. “Conversely, those less comfortable will have reduced prominence in the industry going forward. The net impact of this will dictate who remains in the beef producing business and characterize what the industry offers to potential consumers,” he says.

“Overall, I remain bullish about the prospects for producers relatively comfortable with this ‘new environment.’ I encourage industry stakeholders to stay attuned to the set of issues that face the industry,” Tonsor says.

That makes sense to Fruendt. It’s the approach he’s taken with his operation since he started.

For example, while “risk management” is an important part of his pricing and marketing strategy, he’s taking steps to protect his forage as well as cattle. His plan includes using a blend of cover crops to help increase grazing opportunities.

“We just can’t always count on our native grasses, wheat or Bermuda to provide the forage we need, especially with the dry conditions,” he says. “So we have been using a cover crop mix that includes triticale, rye, barley and oats. There is also some red clover and turnip. That mix can respond to rainfall and also helps improve our soil quality.”

Larry Stalcup is an Amarillo, TX-based freelance writer.

 

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