Agrestic Research Blog

Saturday, 07 January 2017 08:08

Understanding a LGM Cattle Crush

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Believe it or not, but Livestock Gross Margin may just be the alternative your producers are looking for in the wake of high volatility markets and expensive Livestock Risk Protection premiums. Let me explain using an example of LGM-Cattle for yearlings and the current LGM-Cattle margin (crush) for July 2016.

LGM-Cattle insurance covers the feeding margin only; it does not cover production risk such as mortality or poor feeding performance. LGM-Cattle places a floor price under the margin, computed as the difference between the value of fed cattle and a combination of feeder cattle and corn values. As such, the coverage is similar to hedging the “cattle crush,” except LGM-Cattle bundles option-style coverage together accounting for correlation among the components. The margin does not cover costs apart from cattle- and corn-related charges. Thus fixed costs and other variable costs could increase and not be protected by LGM-Cattle. It may be attractive as a tool for those who retain ownership or are considering doing so in the future. Cattle feeders and commercial feedlots may also be interested in LGM-Cattle.

LGM-Cattle has two different types of endorsements: one for those finishing yearlings and one for those finishing calves. Coverage for yearlings is designed for 750-pound feeder cattle to be finished to 1,250 pounds. Coverage for calves is designed for 550-pound feeder cattle to be finished to 1,150 pounds. Feed use is a fixed corn (or corn-equivalent) amount. Producers can purchase coverage during a sales window that occurs at the end of a month to cover cattle to be finished over the next 11 months. Producers estimate how many head they will market (and insure) by month for the insurance period.

Livestock Gross Margin (LGM) is a bundled basket of commodities that eliminates buying/selling individual futures contracts to provide a hedge

Margin Example

The expected margin follows a formula dependent on whether the coverage is for yearlings or calves.The LGM-Cattle margins are computed for a given month as follows:

  • Expected Margin (yearlings) t = 12.5 cwt * Live Cattle t – 7.5 cwt * Feeder Cattle t-5 months – 50 bu. * Corn t-2 months
  • Expected Margin (calves) t = 11.5 cwt * Live Cattle t – 5.5 cwt * Feeder Cattle t-8 months – 52 bu. * Corn t-4 months

The live cattle, feeder cattle, and corn prices for a given month are the respective average futures prices from the last three trading days of that month. In non-contract months the commodity price is calculated using a weighted average of surrounding contract month prices.

In the above margin calculation example for the yearlings and using July 2016 as the marketing period the calculation would look like this:

  • Expected Margin (yearlings) July2016 = 12.5 cwt * Live Cattle July2016 – 7.5 cwt * Feeder Cattle February2016 – 50 bu. * Corn May2016

Note that because no futures contracts are available for July Live Cattle or February Feeder Cattle then the average of the 2016 June Live Cattle and 2016 August Live Cattle futures are used for the Expected Live Cattle Price, while the 2016 January Feeder Cattle and 2016 March Feeder Cattle futures are utilized for the Expected Feeder Cattle Price.

A good tool for checking the LGM-Cattle margins is located here. Alternatively, one can build an estimated LGM-Cattle margin using a charting packages such as I have taken the liberty of constructing the LGM-Cattle margin for July 2016 in TradingView. Figure 1 below illustrates this July 2016 LGM-Cattle margin. The important note using this method is that this is only an estimated margin and not true to the actual LGM Commodity Exchange Endorsement that outlines the price measurement period for each futures contract (i.e. this method does not account for only the last 3 trading days of the month, but instead calculates using the last settlement for unexpired contracts). Hence this is only for estimating margins and visualizing them graphically.

The takeaway from Figure 1, is that the July 2016 LGM-Cattle margin is currently higher than it has been in over a year. Even more so, when comparing the current premiums for LRP Fed Cattle with a target weight of 12.50 cwt. and ending in Jul, the LGM-Cattle premiums for the month of July on a per head basis with a zero dollar deductible is cheaper. As of 12/16/2015 LRP fed cattle at the highest coverage level (.9917) and price of $115.50 cost $85.44 per head. In turn the estimated LGM-Cattle premium for the January-November insurance period for cattle marketed in July is $62.80 per head. If at the end of the insurance period, the Actual Gross Margin is less than the Expected Gross Margin an indemnity payment would be due.

Figure 1) Estimated LGM-Cattle Margin (crush)

Livestock Gross Margin Cattle Formula

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