Marketing strategies available to cattle producers: an analysis and comparison of hedging and options

Date
1987-12
Journal Title
Journal ISSN
Volume Title
Publisher
Texas Tech University
Abstract

Major changes in the cattle feeding industry have substantially increased price risk faced by livestock producers. The purpose of this study was to assess the usefulness of options on live cattle futures contracts in reducing price risk as compared to hedged and unhedged strategies.

Appropriate data were collected and analyzed under a single-valued risk-reward utility function using mean-variance analysis and a quadratic risk-reward utility function using portfolio analysis for five- and six-month feeding regimes. Returns to working capital were calculated resulting in negative rates of return for each strategy. Investigation of why cattle feeders would continue to produce when average rates of return were negative led to the conclusion that many producers consider only feeder and feed costs.

Rates of return above feeder and feed cost were then determined for each strategy. Writing "covered" calls dominated all marketing strategies. Inspection of these results showed a distinct biannual cyclical pattern for lower/higher monthly returns. The rates of return were re-estimated for divided placement periods of Spring/Summer (S/S) and Fall/Winter (F/W). Writing calls and buying puts had the highest rate of return for S/S and F/W placement, respectively.

Quadratic risk-reward utility functions were estimated using portfolio analysis. Writing "covered" calls also dominated continuous and S/S placements when addressing risk and reward simultaneously; a riskless hedge using puts provided the same results for F/W placement.

Rates of return were also estimated into the future using different price expectation models. The strategies to use were consistently shown to be specific to time period and the associated price trend.

The inclusion of put options in portfolio analysis caused the efficient E-M frontier to flatten out and shift upward enlarging the opportunity set. When writing "covered" calls in a sideways/downward trending market, no E-M surface was traced out.

Description
Keywords
Hedging (Finance), Cattle trade, Options (Finance), Cattle -- Marketing, Option (Contract)
Citation