Earlier this year, the USDA’s Risk Management Agency changed its Livestock Risk Protection insurance allowing covered producers to collect indemnity payments if they sell insured cattle within the last 60 days of coverage, and it pays to know the implications of the change.
The analysis was covered by Matthew Diersen, risk and business management specialist at South Dakota State University, in a letter to Extension Agents through the Livestock Marketing Information Center’s “In The Cattle Markets.”
Prior to the change, the limit was the last 30 days of coverage. The change makes an LRP policy more flexible and therefore more attractive for cattle producers, he said.
LRP is sold with fixed end dates from 13 to 52 weeks out in four-week intervals — basically, monthly end dates — to span the time they own the cattle, Diersen said. LRP cannot be exercised or offset prior to the end date, but coverage can be transferred to another party like the buyer of the cattle.
Consider a feedlot in early June expecting a pen of cattle to finish in mid-October, Diersen said. The feedlot buys LRP at a high coverage level with an end date in late October.
If the cattle gain well and finish in mid-September and prices remain steady or increase, the cattle can be sold and the LRP premium paid, he said. But if prices fall, the feedlot would be expecting an indemnity payment.
Under the prior policy, selling the cattle earlier than 30 days before the end date either meant foregoing any indemnity (because the coverage stopped) or transferring the coverage to the buyer, Diersen said. Regardless, the premium still needed to be paid.
But now the window is 60 days before the end date. He said, using recent market conditions, the difference in time value between 60 and 30 days from expiration is about $1.00 per cwt for an at-the-money live cattle put option (or 100% coverage LRP on fed cattle).
That value could have been foregone in the past if not captured when transferring the coverage, Diersen said. So, being able to keep LRP coverage for the wider window is worth $1.00 per cwt for the fraction of the time cattle are sold early.
If the likely end value is much higher than the original expected end value, the remaining value of the LRP coverage is very small regardless of the window, he said. If the likely end value is much lower, then the expected indemnity is analogous to the intrinsic value of a put option, and it would serve as a lower bound if considering transferring the coverage.
CATTLE, BEEF RECAP
Fed cattle traded this week at $119 to $120.50 per cwt on a live basis, down $0.50 to up $0.50 from last week. Dressed-basis trading was at $189 to $191, steady to down $1.
The USDA choice cutout Tuesday was up $0.01 per cwt at $338.61, while select was off $2.99 at $306.18. The choice/select spread widened to $32.43 from $29.43 with 90 loads of fabricated product and 18 loads of trimmings and grinds sold into the spot market.
The USDA reported Tuesday that basis bids for corn from livestock feeding operations in the Southern Plains were unchanged at $1.00 to $1.07 a bushel over the Jul futures and for southwest Kansas were unchanged at $0.70 over Jul, which settled at $6.80 a bushel, up $0.00 3/4.
The CME Feeder Cattle Index for the seven days ended Monday was $140.12 per cwt down $0.95. This compares with Tuesday’s Aug contract settlement of $149.25 per cwt, down $0.95.