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.