Feuz Cattle & Beef Market Analysis
The Long Fence

Producers of fed cattle or feeder cattle can establish a maximum or "ceiling"  price for grain purchases at reduced premium costs by purchasing a Call Option and selling a Put Option.  This creates both a minimum and a maximum price.  The floor price is equal to the Put Strike price plus the net premium cost and the maximum price is equal to the Call Strike price plus 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 Call option and selling a Put option.  By selling the Put option, a producer may have margin calls if the market falls below the Put strike price.

When the grain is purchased 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 grain prices have decreased below the Put strike price it will have value and the seller of the Put will have to buy it back or be forced to take a long futures position at the strike price. If prices have increased above the Call strike price, then the Call will have value that the producer can capture by selling the Call.

Advantages

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

Disadvantages

  • Downward price opportunity is limited
  • Margin call responsibility for the Put option that was sold

Return to Hedging Alternatives
 
Description of a Long Hedge
Description of a Call