The feeder cattle market has been on a tear since fall of 2022. In most markets, heavy feeders are promoting for $30-$50/cwt. greater than they had been within the fourth quarter. The worth enchancment in calf markets has been even better. The August Chicago Mercantile Trade feeder cattle futures contract that was buying and selling beneath $200/cwt. in early fall is now buying and selling within the mid-$230’s (see chart beneath). There may be a lot cause for optimism as many revenue alternatives exist within the present atmosphere. However sharp value will increase also can create challenges for producers, and I needed to particularly talk about one among these challenges that got here up final week as I used to be having lunch with a buddy of mine that works within the agricultural lender sector.
Whereas there are a number of value danger administration methods that may be employed by cattle producers, a few of these methods contain potential for margin calls. And loads of margin might be wanted when markets make main runs just like the cattle markets have been doing. This could create a big problem for producers that assumed a brief futures place (or wrote a name possibility) as a part of their advertising and marketing plan. Certain, a lot of this will likely be recouped when cattle are finally offered on the upper market. However the short-term liquidity pressure is usually a major problem and is compounded right this moment by a lot increased rates of interest on borrowed cash. I needed to share just a few ideas on this example which might be relevant this yr, and in future years.
First, farmers ought to have a completely clear relationship with their lender. If a farmer’s danger administration plan includes potential for margin calls, the lender ought to concentrate on that from the beginning in order that capital entry might be mentioned. Whereas it will not be doable to plan for all doable situations, analyzing the affect of main market strikes is necessary. Evaluating the impact of declining costs could also be commonplace however strolling by means of rising value situations can also be necessary as a consequence of doable liquidity issues when margin potential exists.
Secondly, producers ought to at the very least take into account danger administration methods that don’t contain the potential for margin. Ahead contracts instantly come to thoughts and are utilized by some. However they are often fairly elusive in risky occasions as patrons are hesitant to cost far prematurely. Put choices and LRP insurance coverage would additionally fall on this class as they permit a producer to have some downward value safety, whereas retaining upside potential. Premium is paid in each instances, however no margin is required as markets transfer.
Producers must also do not forget that there are methods to maneuver out of a marginable place, and into one thing completely different, if situations necessitate doing so. For instance, somebody with a brief futures place might offset that place and buy a put possibility or LRP insurance coverage. And the worth ground set could be reflective of the present, stronger market. Shifting to one among these methods would require premium to be paid however will get rid of the potential for future margin calls. These methods even have the added benefit of permitting the producer to capitalize if costs proceed to rise, which they had been unable to do with the quick futures place.
Lastly, producers that just like the extra stable draw back value safety that comes from a brief futures place, might additionally take into account an artificial put. An instance of this may be preserving the quick futures place however combining it with a name possibility. Premium is paid on the decision possibility, however this additionally permits the producer to capitalize on rising costs as he/she good points on the decision. Plus, as the decision possibility turns into extra worthwhile that works to offset the margin expense to some extent.
To be clear, there may be nothing improper with using a danger administration technique that includes margin. In reality, there may be good advantage in a lot of these methods. I prefer to say that if a farmer isn’t leaving cash on the desk sometimes, they’re in all probability taking an excessive amount of danger. Nevertheless, I do assume that producers ought to take into account all danger administration instruments at their disposal, together with these that don’t carry potential for margin calls. And most significantly, they need to totally assume by means of the implications of main market swings in each instructions.
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