1 / 19

Evaluating Risk Management Tools

Evaluating Risk Management Tools. John D. Lawrence Extension Livestock Economist Iowa State University. Tools. Futures Forward contracts Options Livestock Revenue Protection Livestock Gross Margin Option combinations. Y-axis is the net price received. Cash is a 45 o line.

dalton-whitehead
Download Presentation

Evaluating Risk Management Tools

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Evaluating Risk Management Tools John D. Lawrence Extension Livestock Economist Iowa State University

  2. Tools • Futures • Forward contracts • Options • Livestock Revenue Protection • Livestock Gross Margin • Option combinations

  3. Y-axis is the net price received Cash is a 45o line X-axis is possible futures prices at end of contract

  4. Futures and Options Data

  5. Establishes a flat price with basis risk around it. • If Futures fall to $80: Cattle are worth $80.56 + Futures gain of $5.80 – Com of $.12 • If Futures rise to $90: Cattle are worth $90.56 – Futures loss of $4.20 – Com of $.12 • In either case the net price is $86.24 +/- the change in basis from expected

  6. Forward Contract v. Futures • They look the same on the graph • Flat price • Difference: Forward contact • Contract with buyer • Must deliver commodity (deliver specs) • Basis is known and no basis risk • No margin calls • Typically flexible sizes

  7. Establishes a floor price, but not a ceiling and has basis risk • At Futures prices below SP: Net price is the Floor Price because the futures gains off set cash price decline, but subtract premium and commission. • At Futures prices above SP: Net price is the cash price minus the premium and commission that have already been paid.

  8. P+C Corner at intersection of Strike and Floor Prices

  9. Compare Futures hedge to ATM Put 45o line so rise/run = 1. “Rise” is P+C is also “Run” from current futures to the futures price where the lines cross Futures has higher net price until the lines cross

  10. Livestock Revenue Protection • Looks like buying put option on graph • Floor price with upside potential • Difference: LRP • Is both through insurance agent • Flexible size of contract • Expiration time is fixed • Cannot be resold • Basis is slightly different as is basis risk

  11. Livestock Gross Margin • Protect a “margin” • Revenue – feed cost – feeder cost • Budgeted quantities and weights • Uses futures prices • Focus on profits not price • Flexible size • Purchased from insurance agents

  12. Combination Option Strategies • Buy one option and sell another • Income from option sold raises the floor • Get premium, but give up something else • Option sellers • Must establish an margin account and will get margin calls if futures price moves against you

  13. Buy 82 Put @ $3.88 Sell 90 Call @ $3.35

  14. Buy 88 put at $6.60 Sell 82 Put at $3.88 This not a floor. It is a shelf There is down side risk, but no ceiling and higher over range of prices.

  15. Summary • Tools are available to include into a well developed marketing plan • Tools have different strengths and weaknesses to achieve different objectives • Understand the math and basis first • Marketing clubs are good ways to learn

More Related