Market Risk Management
Market Risk Management Protecting the “Crush” Margin Shane Ellis Extension Livestock Economist Iowa State University June 9, 2011 1
Commodity Price Index
2
Estimated Returns to Farrow to Finish Hog Production, $/Head, Iowa State University Extension $50 $40 $30 $20 $10 $$(10) $(20) $(30) $(40)
n-1 1 3
Ja
l-1 0 Ju
n-1 0
Ja
l-0 9 Ju
n-0 9
Ja
l-0 8 Ju
n-0 8
Ja
l-0 7 Ju
n-0 7
Ja
l-0 6 Ju
n-0 6
Ja
l-0 5 Ju
n-0 5
Ja
l-0 4 Ju
n-0 4
Ja
l-0 3 Ju
n-0 3
Ja
l-0 2 Ju
n-0 2
Ja
l-0 1 Ju
Ja
n-0 1
$(50)
4
Defining Margin • Margin = Revenue – Cost – Several different levels
• Margin over – Corn – Corn and SBM – Feed costs – Variable cost – Total costs 5
Margin Maker is a risk management education project for livestock producers.
Margin maker programs and materials center on the concept of managing the risk of declining revenues and increasing costs.
6
Calculating Margin • Revenue: 2 cwt @ $90 • Costs – Pig $45/hd – Corn 10 bu @ $7/bu – SBM 150 lbs @ $345/t – Other feed – Non-feed variable – Fixed cost
$180 -45 -70 -26 -8 -12 -12
Margin 135 65 39 31 19 7 7
Normal Price Distribution How big is the SD???
68% of time
16%
2.5%
16% SD
SD
2.5% 8
Basis Std Dev typically $2-4/cwt
Basis has a smaller standard deviation than does cash price
Futures price forecast of Cash Price Std Dev typically 20-30% of price, i.e., $18-27 in $90 market
9
10
WESTERN CORNBELT LEAN HOG BASIS, 2007-2011 FOR THE 51-52% LEAN CARCASS CONTRACT ($/CWT)
Market Period Jan- 1st half Jan- 2nd half Feb- 1st half Feb- 2nd half Mar- 1st half Mar- 2nd half Apr-1st half Apr- 2nd half May-1st half May- 2nd half Jun- 1st half Jun- 2nd half Jul- 1st half Jul- 2nd half Aug- 1st half Aug- 2nd half Sep- 1st half Sep- 2nd half Oct- 1st half Oct- 2nd half Nov- 1st half Nov- 2nd half Dec- 1st half
Cont Mon Feb Feb Feb April April April April June June June June July July Aug Aug Oct Oct Oct Oct Dec Dec Dec Dec
3-yr Avg Futures 70.01 69.45 69.71 73.64 74.26 74.81 76.22 84.43 80.34 79.55 70.81 70.86 70.26 73.06 68.28 60.06 59.21 59.91 58.41 55.92 55.63 57.31 59.61
2007 Basis -4.62 -2.25 -1.07 -3.04 -5.36 -5.45 -3.27 -7.05 -2.48 -0.61 -2.43 1.69 -1.37 -2.98 -1.47 -2.72 -3.39 -0.47 -1.39 -0.37 -4.25 -5.51 -1.67
2008 Basis -8.11 -5.07 -1.99 -4.10 -4.83 -5.12 -1.93 -5.26 0.26 0.35 -3.12 -1.24 -1.29 0.82 -0.89 6.47 2.32 1.32 -0.04 1.36 -3.12 -5.07 -2.96
2009 Basis -6.69 0.67 0.60 -2.90 -1.94 -5.47 -2.66 -8.09 -2.18 -6.85 -1.54 -1.69 -2.19 -3.44 -2.30 -0.17 -0.94 -0.58 -1.23 -2.89 -2.54 -3.75 -1.12
2010 Basis -1.75 -2.74 -2.34 -3.80 -0.98 -4.06 -2.22 -5.17 -3.61 -1.44 -3.09 -2.88 -3.01 -3.94 -2.99 4.15 2.72 2.00 -2.66 -6.49 -7.11 -7.07 -4.65
2011 Basis -8.03 -6.33 -2.88 -10.97 -6.54 -7.54 -4.86 -8.97 -3.15 0.80
3-yr Avg Standard Basis Deviation -5.49 3.71 -2.80 3.16 -1.54 1.97 -5.89 4.30 -3.15 3.01 -5.69 2.00 -3.24 1.69 -7.41 3.24 -2.98 2.23 -2.50 4.02 -2.59 1.21 -1.94 1.42 -2.17 1.01 -2.19 2.94 -2.06 1.43 3.48 3.76 1.37 2.19 0.91 1.59 -1.31 2.39 -2.68 3.63 -4.26 2.53 11 -5.30 2.30 -2.91 2.57
Hedge Example • • • •
Hogs ready for market in 1st Half of December Producer sells Dec LH futures at $84/cwt in June Expected local basis in Dec is -$3/cwt Expected hedge price is $81/cwt ($84 - $3 = $81)
12
Hedge Example • Prices move lower • Futures are 75 when hedge is lifted – Cash price now lower = – Futures gain/loss ($84 – $75)= – Result will be expected price of • Futures gain offset cash loss • Basis is as expected
$72 +$9 $81
13
Hedge Example • Prices move higher • Futures are 90 when hedge is lifted – Cash price now higher = – Futures gain/loss ($84 – $90)= – Result will be expected price of • Futures loss offset cash gain • Basis is as expected
$87 -$6 $81
14
15
Options • Similar to price insurance • Buy a Lean Hogs put option – set a price floor • Buy a Corn or SBM call option – set a price ceiling 16
Put option example • Its June. Hogs to sell in December. Dec LH=$84. 1) Buy Dec Put with Strike Price = $82.00 Expected basis = -$3.00 Premium = $3.90 Expected minimum price (EMP) or Floor SP + Basis - Prem = $75.10
17
Put option example Lower 2) In December futures prices lower. Futures = $75.00 Cash market = $72.00 Option value = $82-75 = $7.00 Net price = Cash + Return - Cost = $72 + 7 – 3.90 = $76.10
18
Put option example Higher 3) At harvest futures prices higher. Futures = $90.00 Cash market = $87.00 Option value = $0 Net price = Cash + Return - Cost = $87.00 + 0 - 3.90 = $83.10
19
Livestock Risk Protection • Guarantees price level only • Coverage based on 150 – 225# lean hog carcass; 203-304# live weight • Coverage levels 70% to 100% • Maximum per SCE is 10,000 head; 32,000 head per crop year (July 1 – June 30) • Producer selects coverage level and end date close to when hogs are expected to go to market
20
21
22
Based on closing futures prices for Placement month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar
Selling month Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
Pig price 48.00 50.44 48.89 41.79 35.08 33.26 41.95 41.95 43.19 43.19 43.90 43.90 45.88 46.88 45.90
June 8, 2011 Basis Adjusted Price for: Lean Corn SBM Hogs 88.01 5.81 347 89.18 6.29 366 88.84 6.77 337 86.42 7.23 336 83.74 6.92 331 79.64 7.25 338 80.99 7.26 379 80.85 7.01 375 85.13 7.01 391 85.22 6.50 364 85.53 6.57 365 89.91 6.67 364 91.16 6.67 355 89.63 6.72 361 88.64 6.72 359
Crush Margin 43.90 37.57 35.82 33.58 38.36 28.15 19.01 21.56 27.64 34.97 34.14 41.98 43.12 38.17 37.28 23
Wean-Finish Crush Margin The Crush Margin is the return over pig, corn and SBM cost. The Crush Margin is based on the following assumptions. Carcass weight: 200 pounds Corn: 10 bu/hd Farms differ, but approximately a $40 margin is needed to breakeven Pig price: 50% of 5 month out LHF SBM: 150 lbs/hd
24
www.econ.iastate.edu/margins
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs in Barn: Cash Pig, Corn & SBM Price at Placement and Wednesday Lean Hog Futures Prices
25
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs Placed in Next 5 Months : Wednesday Futures Prices for Lean Hogs, Weaned Pigs and SBM
26
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs Placed 6-11 Months Out : Wednesday Futures Prices for Lean Hogs, Weaned Pigs and SBM
27
Livestock Gross Margin • Insures the gross margin – the difference between the lean hog price and cost of feed (corn and soybean meal) • Like purchasing options on lean hogs, corn and SB meal • Actual margin is calculated at the end of the insurance period and, if less than the insured expected gross margin, an indemnity is paid. • Hogs finish @ 260# • Farrow to Finish operation – Consume 13.86 bu. Corn and 196.16# of SB Meal
• Feeder pig finishing operation – Consume 9.6 bu. Corn and 136# of SB Meal
• SEW pig finishing operation – Consume 9.7 bu. Corn and 142# of SB Meal
28
Livestock Gross Margin • Insurance period is 6 months with no hogs insured in 1st month • Producer selects number of hogs to be covered during each month of the insurance period and a deductible off the expected margin • Producer chooses deductible amount from $0 to $20 per head in $2 increments off the expected margin • Maximum of 15,000 hogs insured in any insurance period; 30,000 hogs in a year; no minimum number
29
Conclusions • • • • • •
Manage the margin Hedges Option LRP LGM You can not insure yourself to prosperity
30
Thank you
Questions? Shane Ellis [email protected] www.econ.iastate.edu/ifo www.econ.iastate.edu/margins www.econ.iastate.edu/basis 515-294-8030 31
Commodity Price Index
2
Estimated Returns to Farrow to Finish Hog Production, $/Head, Iowa State University Extension $50 $40 $30 $20 $10 $$(10) $(20) $(30) $(40)
n-1 1 3
Ja
l-1 0 Ju
n-1 0
Ja
l-0 9 Ju
n-0 9
Ja
l-0 8 Ju
n-0 8
Ja
l-0 7 Ju
n-0 7
Ja
l-0 6 Ju
n-0 6
Ja
l-0 5 Ju
n-0 5
Ja
l-0 4 Ju
n-0 4
Ja
l-0 3 Ju
n-0 3
Ja
l-0 2 Ju
n-0 2
Ja
l-0 1 Ju
Ja
n-0 1
$(50)
4
Defining Margin • Margin = Revenue – Cost – Several different levels
• Margin over – Corn – Corn and SBM – Feed costs – Variable cost – Total costs 5
Margin Maker is a risk management education project for livestock producers.
Margin maker programs and materials center on the concept of managing the risk of declining revenues and increasing costs.
6
Calculating Margin • Revenue: 2 cwt @ $90 • Costs – Pig $45/hd – Corn 10 bu @ $7/bu – SBM 150 lbs @ $345/t – Other feed – Non-feed variable – Fixed cost
$180 -45 -70 -26 -8 -12 -12
Margin 135 65 39 31 19 7 7
Normal Price Distribution How big is the SD???
68% of time
16%
2.5%
16% SD
SD
2.5% 8
Basis Std Dev typically $2-4/cwt
Basis has a smaller standard deviation than does cash price
Futures price forecast of Cash Price Std Dev typically 20-30% of price, i.e., $18-27 in $90 market
9
10
WESTERN CORNBELT LEAN HOG BASIS, 2007-2011 FOR THE 51-52% LEAN CARCASS CONTRACT ($/CWT)
Market Period Jan- 1st half Jan- 2nd half Feb- 1st half Feb- 2nd half Mar- 1st half Mar- 2nd half Apr-1st half Apr- 2nd half May-1st half May- 2nd half Jun- 1st half Jun- 2nd half Jul- 1st half Jul- 2nd half Aug- 1st half Aug- 2nd half Sep- 1st half Sep- 2nd half Oct- 1st half Oct- 2nd half Nov- 1st half Nov- 2nd half Dec- 1st half
Cont Mon Feb Feb Feb April April April April June June June June July July Aug Aug Oct Oct Oct Oct Dec Dec Dec Dec
3-yr Avg Futures 70.01 69.45 69.71 73.64 74.26 74.81 76.22 84.43 80.34 79.55 70.81 70.86 70.26 73.06 68.28 60.06 59.21 59.91 58.41 55.92 55.63 57.31 59.61
2007 Basis -4.62 -2.25 -1.07 -3.04 -5.36 -5.45 -3.27 -7.05 -2.48 -0.61 -2.43 1.69 -1.37 -2.98 -1.47 -2.72 -3.39 -0.47 -1.39 -0.37 -4.25 -5.51 -1.67
2008 Basis -8.11 -5.07 -1.99 -4.10 -4.83 -5.12 -1.93 -5.26 0.26 0.35 -3.12 -1.24 -1.29 0.82 -0.89 6.47 2.32 1.32 -0.04 1.36 -3.12 -5.07 -2.96
2009 Basis -6.69 0.67 0.60 -2.90 -1.94 -5.47 -2.66 -8.09 -2.18 -6.85 -1.54 -1.69 -2.19 -3.44 -2.30 -0.17 -0.94 -0.58 -1.23 -2.89 -2.54 -3.75 -1.12
2010 Basis -1.75 -2.74 -2.34 -3.80 -0.98 -4.06 -2.22 -5.17 -3.61 -1.44 -3.09 -2.88 -3.01 -3.94 -2.99 4.15 2.72 2.00 -2.66 -6.49 -7.11 -7.07 -4.65
2011 Basis -8.03 -6.33 -2.88 -10.97 -6.54 -7.54 -4.86 -8.97 -3.15 0.80
3-yr Avg Standard Basis Deviation -5.49 3.71 -2.80 3.16 -1.54 1.97 -5.89 4.30 -3.15 3.01 -5.69 2.00 -3.24 1.69 -7.41 3.24 -2.98 2.23 -2.50 4.02 -2.59 1.21 -1.94 1.42 -2.17 1.01 -2.19 2.94 -2.06 1.43 3.48 3.76 1.37 2.19 0.91 1.59 -1.31 2.39 -2.68 3.63 -4.26 2.53 11 -5.30 2.30 -2.91 2.57
Hedge Example • • • •
Hogs ready for market in 1st Half of December Producer sells Dec LH futures at $84/cwt in June Expected local basis in Dec is -$3/cwt Expected hedge price is $81/cwt ($84 - $3 = $81)
12
Hedge Example • Prices move lower • Futures are 75 when hedge is lifted – Cash price now lower = – Futures gain/loss ($84 – $75)= – Result will be expected price of • Futures gain offset cash loss • Basis is as expected
$72 +$9 $81
13
Hedge Example • Prices move higher • Futures are 90 when hedge is lifted – Cash price now higher = – Futures gain/loss ($84 – $90)= – Result will be expected price of • Futures loss offset cash gain • Basis is as expected
$87 -$6 $81
14
15
Options • Similar to price insurance • Buy a Lean Hogs put option – set a price floor • Buy a Corn or SBM call option – set a price ceiling 16
Put option example • Its June. Hogs to sell in December. Dec LH=$84. 1) Buy Dec Put with Strike Price = $82.00 Expected basis = -$3.00 Premium = $3.90 Expected minimum price (EMP) or Floor SP + Basis - Prem = $75.10
17
Put option example Lower 2) In December futures prices lower. Futures = $75.00 Cash market = $72.00 Option value = $82-75 = $7.00 Net price = Cash + Return - Cost = $72 + 7 – 3.90 = $76.10
18
Put option example Higher 3) At harvest futures prices higher. Futures = $90.00 Cash market = $87.00 Option value = $0 Net price = Cash + Return - Cost = $87.00 + 0 - 3.90 = $83.10
19
Livestock Risk Protection • Guarantees price level only • Coverage based on 150 – 225# lean hog carcass; 203-304# live weight • Coverage levels 70% to 100% • Maximum per SCE is 10,000 head; 32,000 head per crop year (July 1 – June 30) • Producer selects coverage level and end date close to when hogs are expected to go to market
20
21
22
Based on closing futures prices for Placement month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar
Selling month Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
Pig price 48.00 50.44 48.89 41.79 35.08 33.26 41.95 41.95 43.19 43.19 43.90 43.90 45.88 46.88 45.90
June 8, 2011 Basis Adjusted Price for: Lean Corn SBM Hogs 88.01 5.81 347 89.18 6.29 366 88.84 6.77 337 86.42 7.23 336 83.74 6.92 331 79.64 7.25 338 80.99 7.26 379 80.85 7.01 375 85.13 7.01 391 85.22 6.50 364 85.53 6.57 365 89.91 6.67 364 91.16 6.67 355 89.63 6.72 361 88.64 6.72 359
Crush Margin 43.90 37.57 35.82 33.58 38.36 28.15 19.01 21.56 27.64 34.97 34.14 41.98 43.12 38.17 37.28 23
Wean-Finish Crush Margin The Crush Margin is the return over pig, corn and SBM cost. The Crush Margin is based on the following assumptions. Carcass weight: 200 pounds Corn: 10 bu/hd Farms differ, but approximately a $40 margin is needed to breakeven Pig price: 50% of 5 month out LHF SBM: 150 lbs/hd
24
www.econ.iastate.edu/margins
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs in Barn: Cash Pig, Corn & SBM Price at Placement and Wednesday Lean Hog Futures Prices
25
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs Placed in Next 5 Months : Wednesday Futures Prices for Lean Hogs, Weaned Pigs and SBM
26
Wean-Finish Crush Margin ($/Head) by Sale Month Pigs Placed 6-11 Months Out : Wednesday Futures Prices for Lean Hogs, Weaned Pigs and SBM
27
Livestock Gross Margin • Insures the gross margin – the difference between the lean hog price and cost of feed (corn and soybean meal) • Like purchasing options on lean hogs, corn and SB meal • Actual margin is calculated at the end of the insurance period and, if less than the insured expected gross margin, an indemnity is paid. • Hogs finish @ 260# • Farrow to Finish operation – Consume 13.86 bu. Corn and 196.16# of SB Meal
• Feeder pig finishing operation – Consume 9.6 bu. Corn and 136# of SB Meal
• SEW pig finishing operation – Consume 9.7 bu. Corn and 142# of SB Meal
28
Livestock Gross Margin • Insurance period is 6 months with no hogs insured in 1st month • Producer selects number of hogs to be covered during each month of the insurance period and a deductible off the expected margin • Producer chooses deductible amount from $0 to $20 per head in $2 increments off the expected margin • Maximum of 15,000 hogs insured in any insurance period; 30,000 hogs in a year; no minimum number
29
Conclusions • • • • • •
Manage the margin Hedges Option LRP LGM You can not insure yourself to prosperity
30
Thank you
Questions? Shane Ellis [email protected] www.econ.iastate.edu/ifo www.econ.iastate.edu/margins www.econ.iastate.edu/basis 515-294-8030 31
