Feuz Cattle & Beef Market Analysis
The Fence

Producers of fed cattle or feeder cattle can establish a minimum or "floor"  price at reduced premium costs by purchasing a Put Option and selling a Call Option.  This creates both a minimum and a maximum price.  The floor price is equal to the Put Strike price less the net premium cost and the maximum price is equal to the Call Strike price less the net premium cost. Often times this strategy can be executed so that the put and call premiums are nearly identical, so that the net premium cost is near zero. The minimum price and the maximum price will vary somewhat due to basis.

This strategy is executed by buying a Put option and selling a Call option.  By selling the Call option, a producer may have margin calls if the market exceeds the call strike price.

When the cattle are sold in the cash market, if the futures market price is between the Put strike and the Call strike, then both options will expire with no value.  If cattle prices have increased above the Call strike price it will have value and the seller of the Call will have to buy it back or be forced to take a short futures position at the strike price. If prices have declined below the Put strike price, then the Put will have value that the producer can capture by selling the Put.

Advantages

  • Establish a minimum price for less cost than simply purchasing a Put option
  • Can generally establish a higher minimum price
  • You can choose the minimum and maximum price that is best for you

Disadvantages

  • Upward price opportunity is limited
  • Margin call responsibility for the Call option that was sold

Example

A producer has some yearling steers on feed.  He expects to sell the fed steers in January.  It is currently October and the producer is wanting to put a price floor under the steers.  In Oct the producer buys a $80.00/cwt. Feb Put Option for $2.50/cwt. and sells a $86.00/cwt Feb Call Option for $2.20/cwt. The expected local basis for January is -$1.00/cwt.  The expected minimum price is the Put strike price minus the net premium cost, plus/minus the basis and the expected maximum price is the Call strike price minus the net premium cost, plus/minus the basis.  In this example the minimum is $78.70/cwt. and the maximum is $84.70/cwt.  The net realized price for three different market situations is presented below:
 
Market Remains at same level

Date
Cash
Options
Basis
October
Expected Minimum Selling
Price = $78.70
Expected Maximum Selling
Price = $84.70
Buy $80 FEB LC Put
for $2.50/cwt
Sell $86 FEB LC Call
for $2.20
Expected
   -$1.00
January
Sell Steers
for $81.00
FEB LC @ $82
Put Option Expires with $0 value
Call Option Expires with $0 value
Actual
   -$1.00


Lose $.30/cwt

Net Realized Price=Cash Price +/- Gain/Loss in Options = $81.00 - $0.30 = $80.70
Market Strengthens
Market Weakens
Date
Cash
Options
Basis
October
Expected Minimum Selling
Price = $78.70
Expected Maximum Selling
Price = $84.70
Buy $80 FEB LC Put
for $2.50/cwt
Sell $86 FEB LC Call
for $2.20
Expected
   -$1.00
January
Sell Steers
for $90.00
FEB LC @ $91
Put Option Expires with $0 value
Must Buy Call Option for $5.00 value
Actual
   -$1.00


Lose $5.30/cwt

Net Realized Price=Cash Price +/- Gain/Loss in Options = $90.00 - $5.30 = $84.70
Date
Cash
Options
Basis
October
Expected Minimum Selling
Price = $78.70
Expected Maximum Selling
Price = $84.70
Buy $80 FEB LC Put
for $2.50/cwt
Sell $86 FEB LC Call
for $2.20
Expected
   -$1.00
January
Sell Steers
for $73.00
FEB LC @ $74
Sell Put Option for $6.00 value
Call Option Expires with $0 value
Actual
   -$1.00


Gain $5.70/cwt

Net Realized Price=Cash Price +/- Gain/Loss in Options = $73.00+ $5.70 = $78.70
Return to Hedging Alternatives
 
Description of a Short Hedge
Description of a Put