Questions about whether Livestock Risk Protection premiums adjusted with volatility in the market like options do can be answered in the affirmative, said Mathew Kiersen, risk and business management specialist at South Dakota State University in a Livestock Marketing Information Center release called In The Cattle Markets.
Like options, LRP has several moving parts, Diersen said. However, expected (or implied) volatility is the only aspect that is not known.
VOLITILITY LOW FOR NOW
The CME Group provides LEVL, which is an index of volatility levels for nearby live cattle contracts, Diersen said. Recent volatility in this market has been about 12%, a relatively low level for live cattle. In late August, the volatility was above 16%.
How do the premiums compare under different volatility levels? An at-the-money put option on the April Live Cattle contract settled at $5.05 per cwt, he said. Similar LRP coverage had a full cost of $6.37 per cwt, as LRP is generally more expensive before its subsidy is applied.
A put with a $160 strike price settled at $0.35 per cwt, and the $160 LRP coverage was $0.42 per cwt, Diersen said. The full cost is similar at low volatility levels across strike prices for options and LRP.
What about when the volatility was higher, he asked? An at-the-money put on the Dec live cattle contract settled at $6.10 cwt on Aug. 20. Similar LRP coverage also was higher at $8.26 per cwt or more expensive before its subsidy.
The driver behind the premium differences can be reduced to differences in the volatility across the different dates, Diersen said.
TRACKING USDA REPORTS AND VOLATILITY
The NASS publication Price Reactions After USDA Livestock Reports tracks the changes in cash prices before and after Cattle on Feed reports, he said. Researchers have had trouble finding consistent biases or differences in magnitude around the reports. So, is there some consistent bias that is not yet common knowledge in the market?
The Cattle on Feed report is released on Fridays after trading has closed for futures and options markets, Diersen said. Predicting price responses is complicated by the nature of reports.
Sometimes surprises move nearby live or feeder futures. Sometimes surprises move deferred months, he said. Maybe the implied volatility is high on report dates and falls the next trading day.
However, the shortest duration for LRP is 13 weeks out, and premiums mute volatility changes. This aspect should not concern hedgers anyway, he said. If the volatility is irrationally high on report dates, then not buying coverage on those dates would make hedgers better off.
CATTLE, BEEF RECAP
The USDA reported formula and contract base prices for live FOB steers and heifers this week ranged from $191.52 per cwt to $194.79, compared with last week’s range of $191.08 to $193.82 per cwt. FOB dressed steers, and heifers went for $299.65 per cwt to $305.81, compared with $297.79 to $304.38.
The USDA choice cutout Thursday was up $5.85 per cwt at $320.69 while select was off $1.44 at $284.11. The choice/select spread widened to $36.58 from $29.29 with 81 loads of fabricated product and 17 loads of trimmings and grinds sold into the spot market.
The USDA-listed weighted average wholesale price for fresh 90% lean beef was $318.86 per cwt, and 50% beef was $81.98.
The USDA said basis bids for corn from feeders in the Southern Plains were unchanged at $1.19 to $1.35 a bushel over the Mar corn contract, which settled at $4.40 3/4, up $0.03 1/2.
No delivery intentions were posted for the Dec live cattle contract Thursday.
The CME Feeder Cattle Index for the seven days ended Wednesday was $262.23 per cwt, down $0.77. This compares with Thursday’s Jan contract settlement of $254.47, down $2.52.