July 1 changes in the USDA’s Livestock Risk Protection insurance plan renewed a debate about which is better, with some saying the increased subsidies and payment changes make LRP the better choice and others saying it is only insurance and nothing more.
LRP and put options are designed to protect livestock values from downside risk.
Two major changes were implemented for LRP with this marketing year. The premium subsidy was increased and the premium payment date was moved from the time of purchase until the end of the coverage.
LRP VS PUTS
Matthew Diersen, risk and business management specialist for the Ness School of Management & Economics at South Dakota State University, in a publication from the Livestock Marketing Information Center called In The Cattle Markets, said current prices and subsidies favored the LRP product.
Nevil Speer, cattle industry consultant, in Bowling Green, KY, said the higher subsidy rate makes a large difference. However, he pointed out that over time, options generally provide greater flexibility in terms of entry points – not to mentions some ability to resell the option at a later date (albeit at a lower level because of time decay).
“When you buy a put option, you can sell it again and recover part of your investment if your risk management needs change,” Speer said. “When you buy insurance, that’s all you have. As such, producers should weigh their alternatives carefully.”
A cost comparison from July 2 shows the LRP on feeder cattle for the standard weight class had premium quotes for an Oct. 29 end date. The highest coverage level available was $136 per cwt at a full premium cost of $6.82. The subsidy (25% for this coverage level) would reduce the cost to $5.12 per cwt.
A $136 strike price Oct put option on the same date settled at a premium of $6.00 per cwt, Diersen said. The premium would not include commission costs, which could add $0.15 per cwt.
The fixed size of option contracts may give LRP an additional cost advantage as it is purchased on a per-head level. So, the subsidy would give a cost advantage to LRP, Diersen said.
LRP SUBSIDY INCREASED
The LRP subsidy was increased substantially a year ago, with limited effect in terms of volume of cattle covered, Diersen said. For fed cattle, there was an increase in the number covered in the 2020 commodity year to 8,098 across 62 paid policies.
For feeder cattle, there was a decrease in the number covered from the prior year, down to 79,846 across 393 paid policies, Diersen said. The higher volatility in 2020 has resulted in sharply higher premium levels, so the subsidy is more relevant at this time.
TIME CHANGE
Changing the time the LRP premium is payable is more subtle, Diersen said. When buying options, the premium can use a substantial amount of financial capital.
Lenders often will lend the necessary capital, but interest will add to the expense, although interest rates generally are low at this time, Diersen said.
CATTLE, BEEF RECAP
Fed cattle sold this week at $94 to $96 per cwt on a live basis, steady to up $1 from last week and at $155 to $160 dressed, up $3 to $5.
The USDA choice cutout Thursday was down $0.24 per cwt at $203.59, while select was down $0.69 at $194.83. The choice/select spread widened to $8.76 from $8.32 with 109 loads of fabricated product sold into the spot market.
The CME Feeder Cattle index for the seven days ended Wednesday was $133.69 per cwt, up $3.54. This compares with Thursday’s Aug contract settlement of $134.52, up $0.47.