There exists a simple tool that might make hedging your calves easy and more profitable.
Darwin Pluhar, formerly a hedge manager for a large cattle feeder and now a rancher with his wife near Canyon, Texas, refers to his method "one tool, one rule." It uses two simple moving averages to put the producer in the futures market when it's trending down, and to keep him or her out when it's trending up.
The two indicators to use are the 7-day and 13-day averages of closing prices on the nearby feeder contract. It's a simple hedge trade, with no options or buy-and-sell combinations. If you are hedging your calf crop, when the price of the 7-day average goes below the price of the 13-day average, you sell or go short enough futures contracts to cover your calf crop. When the 7-day average goes back above the 13-day average, you lift the hedge and let your cattle make the money by appreciating.
Just a few minutes every day is what it takes to be successful, Pluhar says. Typically, most people would check the closing price on feeder cattle in the evening and log it into a spreadsheet or onto a records sheet and calculate the new averages. Beef Producer has created a simple Excel spreadsheet you can use for this task. It can be downloaded as a Google document at bit.ly/hedgingtool. Just delete the old numbers and fill in new numbers for the current contract.
If you are a stocker operator wanting to protect the price you pay for feeder cattle, you would use the tool conversely. Therefore just reverse the process, going long when the 7-day average goes above the 13-day average.
Pluhar grew up in Montana on a ranch, then went to college and graduate school to study the cattle markets. He worked for Paul Engler at Cactus Feeders for about a decade, analyzing the markets and hedging millions of dollars worth of cattle to assure a profit. The average return at the time was a loss of $35 per head: Pluhar's job was to make $10 per head profit.
"It became clear to me that the average cow-calf and stocker producer was no match for the average cattle feeder, and a lack of marketing savvy was the biggest difference between the segments of the industry," he says.
After 10 years in the feeding industry he started his own business advising producers on marketing and the markets. His business is Diamond M Bar Livestock Futures and Consulting. He says this method is a proven, unemotional and successful way to hedge cattle and have the discipline to apply the strategy, he adds.
- Start a simple spreadsheet.
- You will enter one number per day, and calculate two numbers.
- It can be done early or late. Pluhar commonly does his spreadsheets at night.
- Search online for the nearby feeder cattle futures and get the most recent closing prices.
- Begin by recording the closing prices for the past seven days, then figuring a seven-day average. Also begin daily calculating a 13-day average. These are your two key indicators.
- As long as the seven-day average is above (larger than) the 13-day average, there is no need to hedge your feeder cattle, Pluhar explains.
"The day it goes from positive to negative is the day you hedge your feeder cattle by selling a futures contract MOC," he continues. MOC is a "market on close" order for your broker to make the trade at the closing bell that next day. You will stay hedged as long as the seven-day average remains below the 13-day average. When the seven-day average moves above the 13-day average again, you lift the hedge.
If you are buying feeder cattle and hedging to protect your input prices, the process is simply reversed so you hedge long (buy) feeder cattle when the seven-day average goes above the 13-day average, and lift the hedge when it goes below.
At the time Beef Producer saw Pluhar's presentation last December, he noted there were only four days you would have taken action in the previous 64 days. This is pretty typical, he says, and certainly not very time consuming.
In addition, in that same 64 days, he showed data that his system would have improved the bottom line for feeder cattle producers by just over $40 per head.
When the tool tells you to hedge, you need to be fully hedged.
You will learn to anticipate when the averages are going to cross, Pluhar adds. You can then give your broker a market-on-close order (MOC) early in the morning and go on about your business.
Further, not every crossover of the averages will provide a profit, but over time the fact you will be protected in the market will pay you profits, Pluhar says.
Beef Producer used Pluhar's tool to track the market on homegrown Excel spreadsheet since April 1 using the August feeder cattle contract. As of August 12, we found you would have been short in the market from April 27 to July 5. Then you'd have gone short on July 24 and out on July 29. Then back short on August 7, with an end to our tracking for this story on August 19.
Not counting brokerage fees, banking expenses or similar costs, you would have held onto $12.50 per hundredweight in the first hedge. The second hedge would have netted you 53 cents per hundredweight. The third hedge, as of the market close on August 19, would have been protected by $3.73 per hundredweight and would have covered you during the ugly market downturn after the Tyson packing plant fire in early August.
Eight market terms you need to know
If you're not familiar with the world of futures, here are a few definitions and explanations you need to know:
- Short hedge -- a cattlemen's tool to protect you from a down market. Short means to sell.
- Long hedge -- a cattlemen's tool to protect you on price for cattle you're wanting to purchase. Long means to buy.
- Closing price -- Closing price at the end of the day.
- Market on Close (MOC) -- Instructions to broker to make the trade at the closing bell that day.
- Contract size is 50,000 pounds
- Contract month is month of expiration. There is a calendar of expiration dates and your broker will have these, as well.
- Open interest -- how many trades are still open in that contract month. This matters because of liquidity and ability to enter and/or exit the market.
- Margin or performance bond -- This is a cash guarantee all parties involved will honor that contract.
Also, if you find this system works and decide to use it, you will need to make arrangements with a broker to enact these entries and exits. You may also need to arrange with your banker in the event you need to cover some small losses from swings in the market.