Questions about hedging cattle prices?

[cakadu]

Can anyone give me some details about hedging cattle prices.
I guess I could go to a broker, but I'd like some background from some of you real folks first.
From what I understand you set a price and then buy an option. A call option lets you take advantage of a price spike should your set price be lower than the market that week.
Any details would be of help.

[rsomer]

Remember a call option gains value when the underlying futures contract rises. A put gains value when the value of the underlying futures contract falls. The example you use would work for someone wishing price protection against the possibility of feeder prices rising at some point in the future when they intend to actually buy feeders. Someone who already owns calves and wishes to purchase protection from prices falling at some time in the future when they plan to sell their calves would buy a put. Two things to watch out for are decay and delta. The option value will decay if it is out of the money as it approaches the expiry date. For example an out of the money option will loose value every day as it nears the expiry date even if the underlying futures remains unchanged. Also the value of the option may not exactly follow the change in the value of the underlying futures. The futures might change $1 but the option would only change $0.50. especially if it is at the money or out of the money. This is called the delta factor. Delta disappears as the option approaches maturity but then decay becomes an issue. The hedger/speculator might have to consider increasing the quantity of options traded to provide the required price protection due to the delta factor which effectively increases the premium cost. Something I prefer is to go short on the futures market and also purchase a call option to cover margin calls if the market does not move as I anticipated. The advantage of options are no margin calls, the disadvantage is the premium cost, the delta and decay.

[cswilson]

We've fed cattle here for years and while I'll use the futuires price for my management decisions-I live and die with the cash market-I honestly think we aren't any money behind by this strategy. As an example in '96-grass cattle were trading from40-75 a pound while the Oct. futures were at around 80 cents. We bought a bunch of plainer cattle in midjune and almost doubled our money on them. This is an extreme example but that is how we use the futures market. The last few years all our finished cattle have been sold on a quality grid.