AgDM newsletter article, October 2000

Live cattle futures and options: How have they done? Part 2.

John LawrenceBy John Lawrence, Extension Livestock Economist and Director of the Iowa Beef Center, 515.294.6290, jdlaw@iastate.edu

Futures markets have been available since the mid-1960s and option markets since the early 1980s. Although we still hold educational meetings on how they work, relatively few producers use these tools. Below is a discussion of a recent analysis of futures and options and their effectiveness over the last decade.

Comparing futures and options strategies to the cash market

An analysis of simple futures and option strategies is summarized below. The cost of production estimates are based on Returns from Cattle Feeding, Handbook Decision Files B1-35 and B1-36. These estimates are based on feeding a yearling steer from 750 to 1250 pounds over a six month feeding period and a steer calf from 550 to 1150 pounds over 8 months. Futures were sold (hedge placed) when the cattle went on feed and were bought back (hedge lifted) when the cattle were sold. Similarly, put options were bought (call options sold) at start of the feeding period and were sold (call options bought back) at the end of the feeding period.

During the time period studied, returns were higher for the yearling feeders (Table 1) than calf feeders (Table 2). The 0 percent hedged column shows the estimated returns from staying in the cash market. Futures used at any level did not enhance price over the cash market because average returns were lower for all futures levels compared across all months. However, hedged yearlings sold in May and August had higher returns than the cash market. Calves sold in May and December had higher returns when hedged than the cash market.

Futures did reduce price risk. Hedging produced a higher minimum return and higher return at the 25th percentile (75 percent of the returns are better than this figure) than did the cash market. The 50th percentile, or median, return was higher for yearlings in the cash market than hedged and the calves had mixed results.

Table 1. Average returns for feeding steer calves, 550 - 1150 pounds, hedged at different levels, 1991-99 ($/head).

Percent hedged

Sold

0%

25%

50%

75%

100%

January

$1

$-1

$-3

$-5

$-8

February

17

13

9

5

1

March

34

30

26

22

19

April

28

25

23

20

17

May

22

23

25

27

28

June

11

10

8

7

6

July

-7

-9

-12

-15

-17

August

-8

-11

-14

-17

-20

September

-13

-15

-18

-21

-23

October

-13

-15

-17

-19

-21

November

-14

-15

-16

-18

-19

December

-24

-23

-21

-20

-18

Average

3

1

-1

-3

-5

Minimum

-126

-111

-102

-102

-101

25th percentile

-58

-50

-39

-32

-28

50th percentile

-2

1

2

-6

-3

 

Table 2. Average returns for feeding yearling steers, 750 - 1250 pounds, hedged at different levels, 1991-99 ($/head).

Percent hedged

Sold

0%

25%

50%

75%

100%

January

$15

$15

$15

$15

$15

February

26

23

20

17

13

March

43

38

32

26

20

April

37

33

29

25

21

May

9

11

13

15

17

June

-22

-23

-24

-25

-27

July

-22

-23

-23

-24

-24

August

-10

-10

-10

-10

-10

September

2

-0

-2

-4

-6

October

20

17

14

10

7

November

34

30

26

22

18

December

11

12

13

13

14

Average

12

10

8

7

5

Minimum

-139

-113

-92

-92

-93

25th percentile

-41

-33

-24

-18

-20

50th percentile

21

20

12

4

5

Table 3. Summary of returns to yearlings by month sold and risk management tool, 1991-99, ($/head)

Summary and distribution of returns by risk management tool

0%

50%

100%

100%

100%

100%

100%

Hedge

Hedge

Hedge

OTM PUT

ATM PUT

ITM PUT

OTM

FENCE

Average

$12

$8

$5

$6

$6

$7

$6

Minimum

-139

-92

-93

-105

-108

-113

-93

25th Percentile

-41

-24

-20

-29

-31

-27

-20

50th Percentile

21

12

5

9

11

11

13

<-$30 (%)

32

20

16

25

26

23

24

$30-0 (%)

9

19

29

15

15

19

15

$0-30 (%)

13

31

29

30

30

29

29

$30-60 (%)

19

19

21

16

17

19

22

$60-90 (%)

16

7

4

8

8

6

9

$90-120 (%)

5

3

2

5

3

4

1

$120+ (%)

6

0

0

2

2

1

0

Average return by month sold and risk management tool, 1991-99

Average return by month sold and risk management tool, 1991-99

0%

50%

100%

100%

100%

100%

100%

Hedge

Hedge

Hedge

OTM Put

ATM Put

ITM Put

OTM

January

$15

$15

$15

$16

$17

$21

$16

February

26

20

13

22

22

24

20

March

43

32

20

35

31

28

25

April

37

29

21

27

24

20

22

May

9

13

17

7

9

12

10

June

-22

-24

-27

-29

-28

-26

-19

July

-22

-23

-24

-34

-33

-28

-29

August

-10

-10

-10

-15

-19

-20

-18

September

2

-2

-6

2

3

8

-1

October

20

14

7

22

23

23

19

November

34

26

18

23

22

21

21

December

11

13

14

0

1

0

6

The option strategies considered included:

The OTM and ITM strategies used the first strike price out of or in the money, respectively.

The options strategies were only evaluated for yearlings and produced average returns between those of the 50 percent and 100 percent hedged strategies as shown in Table 3. However, they provided less risk protection than did the futures. The minimum and 25th percentile returns were lower than those provided by futures, but better than the cash market. The 50th percentile returns were comparable to the 50 percent hedged results.

These findings are not surprising since options will always produce the second best outcome. That is, if prices decline, futures will pay off better, and if prices rise, the cash market will pay off better. Put options let you choose which price to take advantage of, but you pay the option premium for the right to choose. Although the differences are not great, there have been months when the option strategies performed better than cash or futures, (i.e., January April and September October) and there are months when they did not fare well (i.e., June August).

 

|Ag Decision Maker Home Page|