An example of calf insurance

The Western Livestock Price Insurance Program is basically the same as buying put options on the Chicago Mercantile Exchange feeder cattle futures. However, this program offers a price in Canadian dollars and also provides a basis for the local region.

Producers should know their costs to determine how much coverage they need.

Here’s a basic example of how it works:

In April, a cow-calf producer plans to sell 600-pound calves in September. The forward expected price is $1.88 per pound and the producer wants to lock in 95 per cent of that price — $1.78 per pound. The premium for this price level is $0.03 per pound, so if the producer has 100 calves expected to weigh 600 pounds each, the total premium cost would be $1,800.

In September, the feeder cattle index for the region for the 550- to 650-weight category falls to $1.68 per pound. The producer would receive $0.10 per pound or $6,000. (If the price is higher than $1.78, then there is no payout.)

Experienced marketers may find an outright short futures position more advantageous because it provides more of a correlated hedge for 100 per cent coverage. However, with WLPIP, there are no margin calls after paying the initial premium. When a producer has a short position on a futures contract, there will be margin calls if the market continues to go up.

Another strategy is to buy put options on feeder cattle and sell out-of-the-money call options. This is essentially equivalent to a short position on the futures market but the margin calls are only necessary if the futures move above the strike price of the out-of-the-money call option.

About the author

Contributor

Jerry Klassen manages the Canadian office of Swiss-based grain trader GAP  SA Grains and Produits Ltd., and is president and founder of Resilient Capital specializing in proprietary commodity futures trading and market analysis. Jerry consults with feedlots on risk management and writes a weekly cattle market commentary. He can be reached at 204 504 8339.

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