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Creating A Price Floor: Locking In calf prices. LRP As A Risk Management Strategy

Jul 30, 2014

By Shannon Sand

For years, cattle producers used the commodities market as a way to hedge and create a price floor for their cattle. For example, suppose a cow-calf producer has 100 head of calves they plan on feeding, knows their breakeven price is $215/cwt, and knows the calves will weigh between 500-600 lbs. when marketed. Using the commodities market, that producer can purchase a hedge to create a price floor for their cattle. This used to be the only option available to producers.  However, a hedge necessitates the purchase of at least one contract, which requires the sale or delivery of 50,000 lbs. Hedging in the commodity market is a good option for producers who know they will be able to deliver at least 50,000 lbs. to market. However, it might not be helpful to smaller producers or those who are uncomfortable with the possible fluctuations in the commodity market.

For those uncomfortable with market fluctuations, smaller producers, or producers looking to diversify their risk management strategy, Livestock Risk Protection (or LRP) may be a good option. LRP is a form of insurance used to insure anywhere from 1-2,000 head of cattle. One advantage of LRP over traditional commodity hedging is there are more categories available, thus allowing producers to pick something more specific for them. For example, a cow-calf producer in South Dakota is not necessarily going to purchase the same kind of coverage that a producer in Texas who owns feeder cattle might. Any producer can find their state’s current LRP prices from the Risk Management Agency (or RMA), a branch of USDA. LRP can be purchased through insurance agents, as well as many banks.

Looking at Table 1, producers can decide what level of coverage they want for their cattle. Table 1 shows the state (South Dakota) variables for the LRP program. The table also shows the commodity and the type (in this case, it is feeder cattle-- specifically steers under 600 lbs.). The table also displays the crop year, the expected ending value, the coverage price, coverage level, rate, and cost per hundred weight, as well as the end date of the policy.

Table 1. LRP Coverage Prices, Rates, and Ending Values for South Dakota Steer Calves weighing less than 600 pounds
 

Exp. End Value

Coverage Price

Coverage Level

Rate

Cost Per CWT

End Date

241.133

$239.810

0.994500

0.031980

7.669

10/06/2014

241.133

$222.210

0.921500

0.008955

1.990

10/06/2014

241.133

$220.010

0.912400

0.007550

1.661

10/06/2014

241.063

$233.310

0.967800

0.023885

5.573

11/03/2014

241.063

$231.110

0.958700

0.020909

4.832

11/03/2014

241.063

$228.910

0.949600

0.018323

4.194

11/03/2014

241.063

$226.710

0.940500

0.016007

3.629

11/03/2014

241.063

$224.510

0.931300

0.013934

3.128

11/03/2014

241.063

$222.310

0.922200

0.012034

2.675

11/03/2014

241.063

$220.110

0.913100

0.010535

2.319

11/03/2014

239.440

$223.710

0.934300

0.013807

3.089

12/01/2014

239.440

$219.310

0.915900

0.010182

2.233

12/01/2014

239.440

$212.710

0.888400

0.006252

1.330

12/01/2014

236.347

$220.620

0.933500

0.016648

3.673

01/05/2015

236.347

$216.220

0.914800

0.012765

2.760

01/05/2015

236.347

$209.620

0.886900

0.008328

1.746

01/05/2015

233.954

$213.220

0.911400

0.017128

3.652

04/06/2015

Continuing with our earlier example of calves weighing between 500-600 lbs. (average weight of 550 lbs.) when they go to market and assuming the producer markets them on December 1 of 2014, the producer knows $215/cwt. (LRP premiums are calculated into the breakeven price) is the breakeven price. Therefore, the producer has several ways to choose their coverage level (see Table 1). In this case the producer needs a coverage level of 91.6% which means if the price dropped below $239.44/ cwt. at market, they would be entitled to a payment of $219.10/ cwt. For the producer to obtain this level of coverage would cost $2.23/ cwt. or $13.38 per head (if the estimated average weight is 550 lbs. round up to 600 lbs.).

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