Risk Management Cash Requirements and Optimal Marketing Strategies for Winter Grazed Stocker Cattle

Abstract

Some agricultural producers use futures contracts and put options as a means of managing price risk. Producers who do not use risk management strategies might be turned away from them due to the margin requirements or the options premiums. They also may need further information in order to evaluate the choice not to pursue risk management strategies. This study uses historical data to determine the optimal risk management strategy (futures contracts or put options). A Monte Carlo simulation is used to simulate the production period of Oklahoma winter grazed stocker steers and heifers and stocker steers from Georgia grazed on winter forage. End of the period wealth is computed across the all three groups of calves for each risk management strategy given a static initial wealth and accounting for the costs associated with purchasing, producing, and hedging cattle. Next, ending wealth is converted into a utility value using a constant relative risk aversion (CRRA) utility function. Next, the producer's certainty equivalent is derived from the utility function to determine the optimal marketing alternative for each group of calves and a non-pooled t-test was conducted to determine the significance between each strategy. A calculation of the margin requirements for a producer who markets their cattle using futures contracts was calculated for all three groups of calves to determine how often and approximately how much money a producer might need during a production period.Results concluded that producers who market their cattle using put options have more to gain in terms of revenue per contract, end of period wealth, and certainty equivalent for all three groups of calves followed by futures and cash markets.