Efficient Cash and Hedged Enterprise Combinations in Feeder Calf Backgrounding Operations

Abstract

Backgrounding of feeder cattle is a growing specialty operation in the so-called “Fescue Belt” grasslands of the South (Bradford et al.). Backgrounding is largely a seasonal enterprise, consisting of the purchase of weaned calves that are placed on pasture and supplemental feed for several months and then resold for placement in feedlots. Since feeder calf and feeder cattle prices are among the most volatile of all classes of cattle, backgrounders face considerable price risk (Russell and Franzmann). In principle, hedging could shift this risk, but there has been a question whether hedging can be worthwhile, given the additional costs and financial obligations involved.

Stochastic Dominance Analysis of Futures and Option Strategies for Hedging Feeder Cattle

“…However, hedging with futures con-ity in cash prices (CCP i ) . This is also shown by tracts is associated with less risk relative to cash standard deviations that are lower for the futures marketing because the ending period basis (Basisi) strategies as compared with their cash marketing is significantly less variable relative to the variabil-counterparts (table 2) previous studies that found that traditional hedging with futures contracts is less risky relative to cash marketing, but only at the cost of lower mean returns (O'Bryan, Bobst, and Davis 1977;Ward and Schimkat, 1979;Bobst, Grunewald, and Davis 1982).…”

“…Hence, he concluded that hedging with futures could be an important marketing tool for reducing the price risks for some backgrounding operators. In a related study, Bobst, Grunewald, and Davis (1982) found that the CME futures contract could be an effective tool for reducing risks given different price expectations for backgrounders. These studies have shown that hedging with futures contracts reduces the risk of backgrounding in the mid-south region, but only at the expense of a significant reduction in average returns.…”

“…Backgrounding is an intermediate stage of production that bears much of the adjustment between the supply of calves and a sometimes volatile demand for feeder cattle. Consequently, feeder cattle prices are among the most volatile of all classes of cattle (Spreen and Arnade 1984;Bobst, Grunewald, and Davis 1982;Russell and Franzmann 1979). Feeder cattle prices are also among the most difficult to predict because several factors affect the demand for cattle by feedlots.…”