Feed acquisition strategies have moved to a priority position for your business this year and will remain there for some time to come.

As government-mandated ethanol production muscles corn prices ever higher, most analysts say feed prices will remain high and continue to be volatile. “High feed prices will be normal for the livestock industry for the foreseeable future,” says RonPlain, University of Missouri agricultural economist.

Consequently, many producers are relying on hedging in the futures and options markets to help manage risk. Others are trying to reduce costs by using alternative feed ingredients. Let’s review both options.

Uncertain and volatile price periods lend themselves to the use of futures and options contracts. “The options market can assist with risk management,” says Thomas Clark, associate director, commodity products, CME Group. “When you’re buying an option, you can consider it as insurance, something you buy in case something unfavorable happens.”

Of course, with inputs, your risk is in facing higher prices; and with your market hogs, the risk is declining prices. “When you buy an options contract you pay a premium, just like you do for insurance,” Clark says. “If an unfavorable pricing situation develops, the premium will expand and you will collect from your option contract. If an unfavorable pricing situation does not occur, the contract expires worthless at the end of the term. You then walk away from it and are only out the cost for the options position.”

In terms of inputs, to address the risk of higher prices in the future, you would be a buyer of futures or a buyer of calls. To protect yourself from a downturn in hog prices, you would be a seller of a futures contract or a buyer of a put.

Utilizing futures contracts can get complex, as well as costly, and you must gain a full understanding before attempting to trade. “You need a broker who understands your business and your personal risk tolerances,” Clark advises.

The concept of covering risk on both sides of the market — inputs and outputs — is a new strategy for some producers. For help in using risk-management tools in your business, the CME Group’s Web site includes information on markets, contracts, rules and regulations, fees and educational materials, including brochures, tutorials and Webinars. The site also contains a free real-time electronic-quotes page with lean-hog futures and options contracts.

Futures and Options Play a Role

Many agricultural economists believe that the futures and options markets have a place in reducing risk. “Today, I would look at using call options to put a lid on feed prices,” says Steve Meyer, president of Paragon Economics. Others agree that as corn prices fluctuate widely, futures and options are becoming an increasingly important risk-management tool.

“I would generally advise a strategy of being a routine buyer to help you dollar-cost-average your grain purchases, along with having call options in place to take out the spikes in price,” says Darrell Mark, University of Nebraska livestock marketing specialist. “Buying or hedging strategies to protect against price increases will be especially important.”

The corn market is certainly holding the wildcard. Mark expects the best buying opportunities will come fairly early this fall, before the majority of harvest occurs. “Early harvest yields look to be lower than expected, so it will be necessary to be aggressive in locking in feed prices,” he says.

USDA surprised the industry in September by dropping the national average corn yield by 2.7 bushels per acre to 152.3 bushels. “Many think the crop may end up even lower than that by the time harvest is over,” Mark notes. “If we end up with less than 12 billion bushels of corn harvested this fall, then producers should start buying feed as quickly as possible.”

Whenever you decide to secure your feed needs, Mark advises focusing on obtaining supplies through early summer 2009.

You can accomplish that objective by buying the physical corn inventory, by using cash forward contracts with growers or elevators, or by implementing call options.

Call options on corn are expensive, however, and may cost 50 cents or more per bushel. So, you must look for ways to reduce the cost of that price protection. Mark suggests a strategy that helps ensure that there’s a revenue stream to pay the cost of the call option, especially when margins are so tight. One way to do that is to set a floor purchase price by selling put options, which lets you get back part of the premium. 

Another strategy to consider is purchasing livestock margin insurance. (Read Mark’s article “Insurance to Help Manage Your Risk”)

Mark also recommends that you keep a close eye on energy prices this winter. Higher energy prices may encourage corn producers to shift acreage to soybeans for the 2009 growing season, which would cause corn prices to rally.

What’s in an Ingredient?

Today, producers also are searching for alternatives to high-priced corn. “In my 25-year career, I’ve never experienced a time when producers have changed swine diets so much by bringing in new ingredients,” says Duane Reese, University of Nebraska swine nutritionist.

If you are considering diet changes, an important first step is to quantify and monitor your pigs’ performance. Reese recommends that you first assemble performance information on your market hogs, such as rate of fat-free lean gain. Then, with that data in hand, make estimates on the nutritional requirements and formulate the diets accordingly.

“Producers could look at replacing some soybean meal with meat and bone meal or amino acids, or replacing some corn with wheat midds or distillers’ dried grains with solubles,” Reese explains.

However, you need to be cautious. Whenever you get into alternative feed ingredients, you often see lower supply, less consistent quality and more variability in nutrient content, he notes.

“If you use alternative feed ingredients, it’s important to rely on lab analysis to assess the nutritional value of that ingredient,” Reese says.

Before you start shopping around for different nutrient sources, have specific standards in mind, such as amino acid and phosphorus levels. If you’re not careful, you can end up with a diet that doesn’t meet the standards you have set.

Reese also suggests that producers work together to cut costs. “If possible, join with other producers to buy feed in larger quantities and qualify for volume discounts,” he recommends. “Put aside differences in opinions about feed ingredients and focus on the bigger picture of how and what you’re going to feed your pigs given the current high feed costs.”

Certainly, now is the time for some new risk-management strategies. “These are different times than you’ve worked in before,” Meyer says. It will challenge your input buying and output selling strategies. Chances are, some combination of futures, options, hedging, alternative-feed ingredients and more will be part of your future solutions.

Help for Hedging 

As the clearing house for futures and options trading, the CME Group provides educational opportunities and assistance related to risk-management tools. One brochure, titled “A Self-study Guide to Hedging with Livestock Futures and Options,” offers a place to find more information on hedging.

Thomas Clark, associate director, commodity products, CME Group, offers some other tips to make your risk-management goals easier to implement. He starts with a guide to finding a broker:

1. Ask fellow pork and crop producers who are using futures and options as part of their risk-management strategies.

2. If you find a potential broker, make sure the person has an agricultural background and understands your business.

3. If the person doesn’t feel like a comfortable fit for you, keep looking. You have to have faith in his or her abilities.

4. Inquire what services are offered. Make sure information resources can be sent directly to you.

5. Ask about the kinds of hedging strategies the person specializes in and what products are preferred by the individual’s firm.

6. This point is mandatory — check the registration of potential brokers with whom you may want to work. Before committing, make sure the person you’re interested in is registered with the National Futures Association. This is a regulatory body that oversees the futures and options trading industry. The group also offers tutorials on futures trading.

Clark also suggests other reports that can help you understand risk management. The Moore Historical Report contains historical data as well as seasonal strategies and moving averages intended to help you make more informed marketing decisions.

Other web resources that can assist you in buying and selling strategies.