k state lrp workshops l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
K-State LRP Workshops PowerPoint Presentation
Download Presentation
K-State LRP Workshops

Loading in 2 Seconds...

play fullscreen
1 / 90

K-State LRP Workshops - PowerPoint PPT Presentation


  • 105 Views
  • Uploaded on

K-State LRP Workshops. James Mintert, G. Art Barnaby Jr., Kevin Dhuyvetter Department of Agricultural Economics Kansas State University. KSU LRP Workshops. Purpose: Improve Cattle Producers’ Risk Management Skills Teach producers How LRP works How to forecast basis

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'K-State LRP Workshops' - serge


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.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
k state lrp workshops

K-State LRP Workshops

James Mintert, G. Art Barnaby Jr., Kevin Dhuyvetter

Department of Agricultural Economics

Kansas State University

ksu lrp workshops
KSU LRP Workshops

Purpose: Improve Cattle Producers’ Risk Management Skills

Teach producers

  • How LRP works
  • How to forecast basis
  • Provide experiential learning opportunity to workshop participants involving use of crop insurance, LRP, cash contracting, & Put Options
lrp workshop partners
LRP Workshop Partners
  • RMA
  • K-State Ag. Economics Department
  • Kansas Farm Management Associations
  • Kansas Livestock Association
importance of partners
Importance of Partners
  • RMA
    • Funding for Program Development & Delivery
  • K-State Ag. Economics Department
    • Develop & Deliver Program
  • KLA & KS Farm Management Associations
    • Target Audience Identification
    • Program Promotion
marketing the program
Marketing The Program
  • K-State Press Release
  • Direct mail to Extension Clientele by County Extension
  • Magazine Advertisement
    • KLA Stockman, reaches about 8,000 producers
  • KLA Weekly Newsletter
    • Calendar of upcoming KLA events
  • Direct mail to all producers in KLA database
  • Direct mail to all Kansas Farm Management Association members that have a cattle operation
  • Radio promotion on K-State’s daily “Ag Today” radio program
workshop format
Workshop Format

Workshops Divided Into Two Parts

Part One

Presentations

  • How LRP works
  • Comparing LRP with CME Put Options
  • Improved basis forecasting
workshop format9
Workshop Format

Workshops Divided Into Two Parts

Part Two

  • Experiential Case Farm Workshop
    • Cow-Calf, Grain Farm Operation
    • Participants provided background information
    • Provided four decision periods
    • Make crop insurance decision
    • Make crop and cattle marketing decisions
part one lrp what is it
Part One: LRP-What Is It?
  • Livestock Risk Protection Insurance
  • LRP for feeder cattle available in KS
    • Provides protection against a decline in CME Feeder Cattle Price Index while you own cattle
    • CME Feeder Cattle Price Index is a 7 day weighted average of cash feeder cattle prices across the U.S.
  • LRP for slaughter cattle is also available in KS
    • Provides protection against a decline in the 5 Area Weighted Average Price reported by USDA
how does lrp work
How Does LRP Work?
  • CME Feeder Cattle Index is used to cash settle Feeder Cattle Futures
    • Since both CME Feeder Cattle futures and LRP use the CME Feeder Cattle Index to settle, purchase of LRP for Feeder Cattle is similar (but not identical) to purchasing a CME Feeder Cattle put option
  • USDA’s 5 Area Weighted Average Price is used to settle LRP for Fed Cattle
    • Purchase of LRP for Fed Cattle is similar (but not identical) to purchasing a CME Fed Cattle put option
how does lrp work12
How Does LRP Work?

To use LRP to protect against a price decline,

  • you would purchase LRP insurance for a particular set of cattle (# of hd. & ending wt.)
  • you must choose
      • Coverage Price (this is similar to an option’s Strike Price)
      • End Date (e.g., the date coverage ends)
  • Price you pay is known as LRP premium
lrp feeder cattle premium calculation example
LRP Feeder Cattle Premium Calculation Example
  • To calculate actual LRP premium you must know
    • Number of cattle ready for market (weighing less than 9.0 cwt) on End Date
    • Target Weight per head
    • Ownership share in cattle
premium calculation example
Premium Calculation Example
  • Producer selects a coverage price which is a % of the Expected End Price published by RMA
  • Assume producer selects $100 per cwt. coverage price (e.g., 92% of RMA’s expected ending price)
  • For this coverage price, the rate is 1.449%
  • The premium subsidy is 13 percent
premium calculation example15
Premium Calculation Example
  • 100 head * 7 cwt = 700 cwt.
  • 700 cwt. * coverage price ($100) = $70,000
  • $70,000 * insured share (1.00)

= $70,000 Insured Value

premium calculation example16
Premium Calculation Example
  • $70,000 * rate of .01449= $1,014 Total Premium
  • $1,014 * .13 (subsidy) = $132 subsidy
  • $1,014 (total premium) minus $132 subsidy = producer premium of $882 = $1.26/cwt. premium
calculating indemnity
Calculating Indemnity
  • Indemnity is payable if actual ending price is less than coverage price
  • Calculate indemnity by:
    • Multiplying number of head by target weight (in live cwt.)
    • Subtract actual ending price from coverage price
    • Multiplying total weight by difference between actual ending & coverage price
indemnity calculation example
Indemnity Calculation Example

Our example

  • An operation has 100 head of fed cattle
  • Has a target weight of 7.00 cwt. per head
  • Insured share is 100 percent
indemnity calculation example19
Indemnity Calculation Example
  • Expected End Price for appropriate insurance period is $109.25 per live cwt.
  • Producer selects a coverage price of $100 per cwt. (e.g., 92% of Exp. End Price)
  • Actual End Price is $80 per cwt. (e.g., CME Feeder Cattle Index = $80 on End Date)
indemnity calculation example20
Indemnity Calculation Example
  • Subtracting actual ending price of $80 from the coverage price of $100 = $20/cwt.
  • Recall that 100 head * 7.00 cwt = 700 cwt.
  • Multiplying 700 cwt. by $20/cwt = $14,000
  • Multiplying $14,000 by insured share of 1.00 = indemnity payment of $14,000
indemnity calculation example21
Indemnity Calculation Example
  • What happens if actual ending price = $105?
  • Subtracting actual ending price of $105 from the coverage price of $100 = neg. $5/cwt.
    • Therefore, no indemnity payment is made to producer
    • This is analogous to a put option that expires worthless
lrp coverage prices levels
LRP Coverage Prices & Levels
  • Price guarantees change daily
  • Premiums change daily
  • Coverage available ranges from 70% to about 95% of Expected Ending Price, but maximum guarantee on most days is less than 95%
premium
Premium
  • Producer may obtain premium quotes via RMA’s Premium Calculator available on USDA-RMA’s web site
  • Premium must be paid on day LRP insurance is purchased for coverage to be provided
  • Rates available at

http://www.rma.usda.gov/tools

Under livestock reports

Or use link on AgManager

www.agmanager.info/livestock/marketing

lrp coverage availability
LRP Coverage Availability
  • Available from about 5 p.m. until 9 a.m. Central Time during the week
  • Not Available on Federal holidays
  • Not Available if RMA web site down
comparing lrp with cme put option premiums for similar coverage
LRP & Put do NOT expire on the same date, most of the time

LRP & Put do not have the same expected price or strike value

LRP is an European Option, no right to exercise

So one can NOT compare cash cost because they do not have the same coverage & expiration dates

Comparing LRP with CME Put Option Premiums for Similar Coverage
comparing lrp with cme put option premiums for similar coverage27
LRP priced using option pricing model

Calculate implied volility from current CME option premiums

Calculate current “fair market” option premium for LRP based on LRP expiration date, European option, LRP expected market price, and LRP strike

Comparing LRP with CME Put Option Premiums for Similar Coverage
what is basis
What is Basis?

Mathematically:

Basis = Cash price – Futures Price

Generally, basis is more predictable than cash or futures prices due to:

  • Convergence
  • Futures and cash prices move together (same fundamental conditions generally affect both markets)
  • Year-to-year stability
how do we use basis
How do we use basis?

Basis = Cash Price – Futures Price

Basis + Futures Price = Cash Price

Exp. Cash Price = Exp. Basis + Futures Price

Risk managers need basis forecasts

LRP users replace futures price with LRP coverage price minus premium

basis as it relates to put options
Basis as it relates to put options

Put option strike (97.9%) $96.00

+ Expected basis 3.50

− Premium 2.13

= Expected minimum sale price $97.37

Based on May FC futures of $98.02 on 2/11/05 and expected selling date of mid May

basis as it relates to lrp
Basis as it relates to LRP

LRP coverage level (93.9%) $92.29

+ Expected basis 4.00

− Premium 1.21

= Expected minimum sale price $95.08

Based on LRP quotes on 2/11/05 and ending date of 5/13/05 (expected ending value = $98.31, 13 week endorsement)

how should you forecast basis
How should you forecast basis?
  • Average over several years (years may vary depending on commodity)
    • Average = expected value
  • Measure variability (risk)
    • Historical range (highs and lows), standard deviation
    • Variability measure indication of risk
slide38

?

4-wk ahead forecast

?

8-wk ahead forecast

Should forecast consider current basis?

How much should we “adjust” forecast by and how will this adjustment vary by time?

including current information improves forecasts but value declines as forecast horizon increases
Including Current Information Improves Forecasts But Value Declines As Forecast Horizon Increases
basis conclusions
Basis Conclusions
  • Basis is generally more predictable than prices.
  • Very important when thinking about basis to make sure relevant/correct prices are used.
  • Ignoring missing data in a multiple year average may lead to poor forecasts
  • Basis is often forecasted using historical basis information, but incorporating “current” information can improve forecast accuracy.
setting up the case farm
Setting Up The Case Farm
  • Participants are provided

Enterprise budgets for

    • Grain sorghum
    • Cow-calf
    • Steer backgrounding
setting up the case farm46
Setting Up The Case Farm
  • Participants must make crop insurance coverage selection at outset
slide48

______

______

______

______

______

______

slide49

______

______

______

______

______

______

slide51

$2.30

$-.40

$0.13

$1.77

YES / NO

slide52

$2.30

$-.40

$0.13

$1.77

YES / NO

15,000

10,000 BU. FORWARD CONTRACT, and 5,000 BU. With a PUT

I UNDERSTAND FORWARD CONTRACT & WANTED TO COMPARE WITH PUT

slide53

$2.30

$0.13

5,000

$1.95

10,000

$19,500

slide54

June 28th Scenario

For Calf Sales in

October 2006

slide56

YES / NO

110 head

Forward Contract 10 weaning steer calves, 10 LRP, & 1 Oct Put

COMPARE LRP with a PUT

slide57

$108

$8

$2.62

$113.38

$114.56

-$1

$1.59

$111.97

slide58

June 28th Scenario

For Feeder Sales

in February 2007

slide60

YES / NO

80 head

FORWARD CONTRACT 10 Feeders, 10 LRP & 1 Mar PUT

slide61

$96

$1

$4.56

$92.44

$96.69

-$3

$4.23

$89.46

slide62

50,000#/90Hd = 555# steer

50,000#/60Hd = 833# steer

90 Calves

60 Steers

$108

$96

$1,309

$2,278

1

1

$114.56

$96.69

$8.34

$33.85

10

10

Total of 150 steers priced using 1 Oct put & 1 Mar put and 20 steers priced using LRP

slide63

$619.50

10

$6195.00

$776

10

$7,760

additional marketing decisions
Additional Marketing Decisions
  • Milo decision in late July
  • Calf-Feeder Cattle Decision in late October
  • Harvest yields drawn from distribution in late October
  • Results from CME put options, LRP insurance, forward contracts recorded
slide65

Oct. 25th Scenario

For Calf Sales

slide66

YES / NO

10 head

Cash Sale 10 steers at weaning

slide67

60 Steers

$108

$96

$1,309

$2,278

1

1

$3,000

$1,691

$1,691

$114.56

$96.69

$8.34

$33.85

10

10

$23.93

$15.59

$155.90

slide70

$96

$1

$3.09

$91.91

$93.73

-$3

$2.17

$88.56

slide71

YES / NO

80 head

FORWARD CONTRACT 10 Feeders, 10 LRP & 1 PUT

slide72

60 Steers

60 Steers

$108

$96

$96

$1,309

$2,278

$1,543

1

1

1

$3,000

$1,691

$1,691

$114.56

$96.69

$93.73

$8.34

$33.85

$17.33

10

10

10

$23.93

$15.59

$155.90

Total of 120 steers priced using 2 Mar puts and 20 steers priced using LRP

slide73

$619.50

10

$6,195

$577.50

10

$5,775

$776

$768

10

10

$7,760

$7,680

slide74

80

50,000

$108,000

slide75

80

50,000

+

$102,150

+

$38,188

+

$0

+

+

$7,000

$108,000

$50,338

lrp summary
LRP Summary

LRP does not guarantee a cash price

LRP protects against a negative change in CME Cash Index Price

LRP does NOT guarantee the basis

Policy does not cover any other peril

lrp summary77
LRP premiums are similar to comparable CME put options

This means USDA subsidy does not provide an incentive to buy LRP vs. CME Put Options

Orders are filled at the stated premium

Deferred options are sometimes thinly traded & it’s difficult to execute option transactions at quoted premiums

LRP Summary
lrp advantages
LRP Advantages
  • Insure the exact number of head that you choose
  • Flexible contract size matches “small” operations vs.
    • Feeder cattle futures that represents about 67 steers weighing 750 pounds
    • Live cattle futures that represents about 33 steers weighing 1200 pounds
  • Can incrementally minimum price a few head at a time
producer s lrp disadvantages
Cannot exercise or cancel LRP contract

Inability to cancel contract inhibits marketing flexibility

Also an issue if cattle are sold early because of drought damaged pastures.

Can not roll up the LRP coverage in a rising market

CME options offer flexibility of “rolling up” coverage

Contracts only offered in 4 week increments

Lack of flexibility creates extra basis risk

Producer’s LRP Disadvantages
producer s lrp disadvantages80
Coverage is always greater than 5% out of the money and in some cases almost 10%

If company exceeds its premium limit, producers with that company’s policy can not buy additional SCEs even though other companies still have capacity to sell

Producer’s LRP Disadvantages
lrp advantages for lenders
Lenders may prefer LRP over a put to cover loan collateral

Producers can’t cancel the coverage

LRP is insurance, so Lenders can take a security interest in the contract

LRP Advantages for Lenders
how effective are the lrp workshops participant evaluation results
How Effective Are The LRP Workshops?Participant Evaluation Results

On a scale of 1 (very useful) through 5 (not useful),

1. How would you rate the overall usefulness of the workshop?

1.70

2. How would you rate the usefulness of the "case farm" exercise?

1.79

how effective are the lrp workshops participant evaluation results84
How Effective Are The LRP Workshops?Participant Evaluation Results

On a scale of 1 (very useful) through 5 (not useful),

3. Would you recommend this workshop to others who have a stake in the cattle business?

1.63

how much did participants learn pre post workshop reviews
How Much Did Participants Learn?Pre & Post Workshop Reviews
  • Are there any limitations regarding how many head of feeder cattle can be insured via LRP for Feeder Cattle? If so, what are the limitations?
  • Who can you purchase LRP insurance from?
  • When purchasing LRP Insurance for Feeder Cattle, what is the maximum insurance coverage price that you can purchase for your feeder cattle on any given day?
  • What published price is the LRP Expected End Value for feeder cattle base on?
how much did participants learn pre post workshop reviews86
How Much Did Participants Learn?Pre & Post Workshop Reviews
  • Assume that you purchased LRP Insurance for 50 head of steers that you own and that you expect the steers will weigh 800 lbs at the end of the coverage period. Also assume that your Coverage Price is $104/cwt and that the CME Feeder Cattle Index value during the ending week is $100/cwt. What indemnity, if any, will you receive from your LRP insurance policy?
  • Have you ever used CME put options?
how much did participants learn pre post workshop reviews87
How Much Did Participants Learn?Pre & Post Workshop Reviews
  • Participants that had used options previously earned higher scores on pre-workshop review than participants that had no options experience
  • 47% correct vs 37% correct
where do we go from here
Where Do We Go From Here?
  • Anticipate conducting more workshops in fall and winter 2005-2006
  • Workshop improvements

consider modifying structure so the entire workshop focuses on case farm with short lectures integrated within the case farm at “teachable moments”

k state lrp workshops90

K-State LRP Workshops

Need More Information:

Email

jmintert@ksu.edu