Development and Use of a Stocker Cattle Market Workshop in Extension Ranch Management Programming

Introduction

Cow-calf producers market their product into the lowest level of a derived demand system that eventually provides beef in many different forms, along with other by-products, to domestic and international markets. Because of that initial position in the marketing chain, calf producers are subject to large changes in prices over a cattle cycle. Large changes in calf prices and production uncertainty make price risk management important to cow-calf producers. Marketing plans that take into account seasonal and cyclical price movements with sound price targets can ameliorate the negative impacts of price risk on cow-calf producing firms.

Data and Methods

This workshop described here introduces calf producers to price risk management techniques by incorporating local market conditions, production practices, and production risk. The workshop begins by distributing a scenario that provides a participant with the financial and production information necessary to develop a marketing plan.

This scenario includes information on the timing of the exercise's production cycle and the size of the cow herd used in the exercise. Pregnancy percentage and pregnancy loss percentage and expected weaning weights for steers and heifers are supplied. Average cost of production per cwt of weaned calf is provided. This background information is based on measures calculated with the National Cattlemen's Beef Association Standardized Performance Analysis (SPA) for South Texas cooperators (Falconer, et al., 1999).

Risk is incorporated by making weaning weights and cost of production dependent on weather, which is determined for each participant by a drawing. Twenty-five percent will experience a drought, 50% normal conditions, and 25% excellent pasture conditions. Cost of production and weaning weights are adjusted based on average changes in cost and production levels in Texas SPA cooperator data in 1993, 1996, and 1998 (Falconer, et al., 1999). Price differentials for the calves are established over the three states of nature. A price "slide" mechanism with an upward adjustment in price for the drought state of nature and downward adjustment in price for the excellent state of nature is used.

Participants are then given a description of the CME Stocker cattle futures contract specifications (Chicago Mercantile Exchange, 1998). During this section of the workshop, pricing strategies that utilize futures and options are reviewed. These strategies stress using futures to short hedge, hedging with at-the-money puts, out-of-the-money puts, and using "fence" strategies.

Participants are provided a historic basis table, which is the last information needed to prepare a marketing plan. These marketing plans can include selling directly into a cash market, short hedging with futures and options, as well as forward cash contracting.

Market information is supplied in six intervals in which participants may execute any portion of their marketing plan. The market information includes a description of the "current" cattle market situation, a price chart of the October stocker cattle futures contract, the "current" October stocker cattle futures price quote, a cash forward contract bid, and "current" option premiums for October stocker cattle futures put and call options.

The market situation and general price action were modeled from the 1993-1994 period. The general market situation presented in each period is paraphrased from various issues of Livestock, Dairy and Poultry Outlook for the 1993-1994 time frame (U.S. Department of Agriculture). This period was selected for a strong seasonal pattern and relatively attractive flat price levels.

Daily futures prices were generated using a random walk process bounded by the daily CME trading limits and adjusted for the monthly seasonal price pattern seen in the 1993-1994 period. These calculations were generated with a MicroSoft Excel spreadsheet using the @Risk (Palisade Corporation) add-in program. Option premiums were based on the generated futures prices using the Black-Scholes option pricing model (Brigham, 1985). Forward cash bids were formulated so participants could focus on a strategy including futures or options. Participants record any pricing action taken at each period on their individual Futures and Options Gains Calculation sheet.

Before receiving the final market situation update, participants draw for their state of nature. The drawing is conducted by having each participant manually select a ticket that contains a particular state of nature, along with summary production and cost of production information that is carried over to the Summary Marketing sheet. The Summary Marketing sheet serves as a mechanism to gather individual performance on the use of futures and options pricing activity and cash price and production information to calculate profitability of the participant's marketing plan as executed.

Participants are then separated by states of nature and asked to provide the entire group with an explanation of how their marketing plan was developed and executed. The participant with the largest return for each state of nature gets a cash prize. The final part of the workshop is an evaluation by participants.

Discussion

The use of simulation has been an effective teaching tool in Extension programming for South Texas clientele. This workshop includes local production and market price behavior so that workshop participants are able to relate quickly to the production and market factors, thereby having more focus on risk management concepts being presented. This workshop has been used in multi-county Extension programming as well as with a statewide Extension program in Texas.

Participants gave the workshop a very favorable rating for being well organized and informative, but they thought that the workshop was complex. Handout materials were rated as being highly useful and effective. The majority of workshop participants indicated that the experience increased their knowledge and interest in using price risk management tools for calves.

The workshop materials are available at http://agfacts.tamu.edu/~lfalcone/llfmasterframeset.html. The workshop materials can be easily adapted to fit other cattle producing regions throughout the country by modifying the document using a word processing package. The authors believe that the use of hands-on teaching methods in conjunction with workshop materials related to specific production regions is an effective method for teaching price risk management concepts to Extension clientele. The authors welcome any questions regarding the workshop materials and their use.

References

Brigham, E.F. (1985). Financial Management: Theory and Practice, Fourth Edition. New York: The Dryden Press.

Chicago Mercantile Exchange. (1998). CME Stocker Seminar Workbook. Chicago, IL: Chicago Mercantile Exchange:.

Chicago Mercantile Exchange. (2000) CME Rule Book, Chapter 95. Chicago IL: Chicago Mercantile Exchange. [On-line]. Available: http://www.cme.com/rulebook

Falconer, L.L., Parker, J.L., & McGrann, J.M. (1999, December). Cost of production analysis for the Texas cow-calf industry. Texas Journal of Agriculture and Natural Resources, 12:7-13.

Palisade Corporation. (1996). Guide to Using @Risk. Newfield, N.Y.: Palisade Corporation.

U.S. Department of Agriculture. Livestock Dairy and Poultry. Economic Research Service. Several issues.