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Matthew Diersen on Cattle Volatility and Options · Professional Ag Marketing Podcast

• 0:01
  SPEAKER_00: Welcome to the Professional Ag Marketing Podcast.
• 0:04
  SPEAKER_00: If you want a deep dive into the egg markets and risk management strategies, your search is over.
• 0:10
  SPEAKER_00: Come here after every Friday to get your weekly commodity recap.
• 0:14
  SPEAKER_00: Trading commodity futures and options involves substantial risk of loss and is not suitable for all investors.
• 0:21
  SPEAKER_00: This is your host, Mike Minor.
• 0:22
  SPEAKER_00: Let's get started.
• 0:23
  SPEAKER_00: Today is April 18th, and I've got a great guest speaker today, a professor at SDSU here in Brookings, South Dakota.
• 0:31
  SPEAKER_00: He is the professor of ag economics here, Matthew Dearson.
• 0:36
  SPEAKER_00: I'm excited to have you on today.
• 0:38
  SPEAKER_01: It's a pleasure to be here.
• 0:39
  SPEAKER_00: Awesome.
• 0:40
  SPEAKER_00: Well, we've got a nice list of topics here.
• 0:42
  SPEAKER_00: We're going to start with uh what you've got going on at SDSU with a couple different classes that you teach and some of the projects uh you have the students working on and whatnot.
• 0:51
  SPEAKER_00: And then we're gonna get into some uh some nitty-gritty details here about some of the other things, uh talking about cattle volatility and then uh talking about option trading and uh expiration around some massive uh reports.
• 1:05
  SPEAKER_00: So I'm really excited to see what you've got to hear, uh got to say on that.
• 1:09
  SPEAKER_01: Yeah, it's uh um this spring semester uh we have a commodity trading class that uh I've been teaching, and the students make a bunch of practice trades in a couple of different uh paper trading accounts, and then we do it for real in terms of taking actual futures or option and or option positions uh in the commodity market, specifically in the ag commodities, when we do it for real.
• 1:37
  SPEAKER_00: Nice.
• 1:38
  SPEAKER_00: So let's talk about a little bit about cattle volatility.
• 1:42
  SPEAKER_00: You had mentioned uh you've spent some time on that recently, and uh I just want to see with with what the markets have done lately in this massive climb in price and record prices now, uh what do you see when you dive into cattle futures uh a little bit more intensely?
• 1:59
  SPEAKER_01: Yeah, if we take a look at both the live cattle and feeder cattle markets, and we go back to the beginning of 2023, the price levels were good, uh, you know, attractive from a seller's perspective.
• 2:09
  SPEAKER_01: Um and at the beginning of the year the uh the the trend had been for very low implied volatility.
• 2:16
  SPEAKER_01: So the the cost to lay off risk in that market, whether you're using options or livestock risk protection, for example, uh it wouldn't be very high.
• 2:26
  SPEAKER_01: Um and then as the prices have continued to increase or slowly increase throughout uh the spring here, uh the volatility has gone from super low levels up to still below average levels.
• 2:40
  SPEAKER_01: So uh it's better prices and volatility still hasn't gone crazy.
• 2:45
  SPEAKER_01: Uh and what do you do to take advantage of that?
• 2:48
  SPEAKER_01: You can still make your marketing decisions or marketing choices now.
• 2:52
  SPEAKER_01: Uh and it's gotten a little more expensive from a volatility perspective.
• 2:58
  SPEAKER_00: So with the the massive climb that we've had and still low volatility in these markets, uh you're suggesting that option premium values are still quite low relative to what price levels we're at today.
• 3:12
  SPEAKER_01: Yes.
• 3:12
  SPEAKER_01: And normally if you get a big run-up in prices or a lot of uh a lot of uncertainty in prices, you'll you'll see the price levels change.
• 3:22
  SPEAKER_01: Price levels will go in this case go up.
• 3:25
  SPEAKER_01: Normally the volatility spikes or goes up, sort of in lockstep with that.
• 3:30
  SPEAKER_01: Um and and so then you have, well, the on the one hand, the good news is the prices are higher and we like that, but the volatility's high too, so now you you really can't get any better floor price than you could have gotten before.
• 3:42
  SPEAKER_01: Um it's not the case now.
• 3:43
  SPEAKER_01: The price level's higher, the volatility's staying in check, it means you're getting better uh floor prices, which really makes um strategies like put options uh attractive because you you're getting a very high floor price and you still leave that upside open if things go um even higher.
• 4:02
  SPEAKER_01: It's uh it's harder to see that on the live cattle side um pushing much beyond high prices, but uh a further decline in corn futures, for example, would really push feeder cattle futures higher.
• 4:18
  SPEAKER_01: So an option in that market might be more um reasonable or attractive to look at because we're gonna face eventually here um corn price uncertainty again as well.
• 4:31
  SPEAKER_00: Do you have any uh any further implications on cattle volatility going forward from here with what we've seen already, or do you expect it to stay low for some time or just unforeseen?
• 4:43
  SPEAKER_01: Well, the you know, what's why is volatility staying low, you kind of have to ask that.
• 4:49
  SPEAKER_01: So if there's been um outside dollars that haven't been able to uh or have looked, uh depends on how you think about this.
• 4:57
  SPEAKER_01: You know, do those outside dollars that supply the volatility, you know, sell the volatility?
• 5:03
  SPEAKER_01: Um if there's better alternatives out there, uh they're they're maybe going to push up the price for volatility, which which would say you know you'd expect volatility to have gone higher here.
• 5:14
  SPEAKER_01: Given the um the general stock market, the economy, those major factors, I would have expected some upward pressure on volatility, which we haven't seen.
• 5:25
  SPEAKER_01: So if those factors are still out there in the general economy, uh I I would take advantage of low volatility while it's here.
• 5:32
  SPEAKER_01: Um and then uh the other thing that happens is you know, once you get um very high prices in say in the live cattle market, um, it does mean you've got some some sort of jockeying positioning going around if you think about you know where will December futures end up and things like that.
• 5:51
  SPEAKER_01: So, you know, that can bring more more just general price volatility into the market.
• 5:58
  SPEAKER_01: And the last one is uh, you know, again, I'll just circle back.
• 6:02
  SPEAKER_01: We're gonna start to have some some serious corn um corn price variation.
• 6:09
  SPEAKER_01: It maybe won't be extreme, but it's the time of year when corn is more volatile.
• 6:14
  SPEAKER_01: You've got um crop conditions and planting progress that come into the market there, moving the price of corn, moving the price of feeder cattle.
• 6:25
  SPEAKER_00: Thank you.
• 6:26
  SPEAKER_00: Let's get into the um option expiration.
• 6:29
  SPEAKER_00: I know you've been working on this uh for quite some time now, and uh around these report days, especially with as high of grain prices as we've had, uh it's really uh important for guys to be looking at option strategies around those uh report days, especially this time of the year now getting into uh the May Wazday report coming up, June planning uh report.
• 6:53
  SPEAKER_00: Uh we're gonna have some major reports at high levels here in price that uh could really change and spark prices one way or another.
• 7:01
  SPEAKER_00: And uh I'm looking to see what uh option strategies you've been looking at and uh kind of what markets uh you like to take advantage of or what you've noticed in these option expiration deals.
• 7:14
  SPEAKER_01: So um as a sort of a prelude to that, um our students here at SDSU have really pushed us to explore and look at different things.
• 7:24
  SPEAKER_01: So they hear about something, uh maybe they hear about it at home or at an internship or something, and they bring that into the classroom and they're like, well, what about these uh short dated new crop options?
• 7:35
  SPEAKER_01: And and we think about that and and then we started to dig into those things a little bit.
• 7:40
  SPEAKER_01: So looking at the current situation, um a couple of types of options really stand out.
• 7:46
  SPEAKER_01: One is weeklies, you know, very short every Friday there's some kind of a weekly option on corn and soybeans, for example, that expires.
• 7:55
  SPEAKER_01: Um you know, but does it make sense to look at those ahead of something like a WASDI report?
• 8:00
  SPEAKER_01: Um from a hedger perspective, if you're thinking about getting some percentage of your crop marketed ahead of a WASDI, you might look at that.
• 8:10
  SPEAKER_01: And um then we've also got the short dated new crop options.
• 8:14
  SPEAKER_01: Um so it sort of lets you separate or think about, oh, I've got this much this many bushels of old crop in the bin, I'm gonna look at a weekly or a short-dated here, but I also have a crop that one of these days will get in the ground here.
• 8:28
  SPEAKER_01: And um what can we do as far as pricing by looking at those options?
• 8:34
  SPEAKER_01: And the advantage or sort of the why would you consider some of these short-dated options?
• 8:41
  SPEAKER_01: The the lower out-of-pocket outlay uh in terms of a smaller premium today, um if you're trying to step in or make some sales for the year.
• 8:51
  SPEAKER_01: And our our studies or our analysis of it suggests if you do wait until very close to these report dates, you get everybody else figures it out too, and you you see the volatility and the cost for these to go up.
• 9:07
  SPEAKER_01: So, you know, it's not something where you want to wait until the last minute and rush in and in in a panic.
• 9:13
  SPEAKER_01: Um, but if you're c calculating about it or you know, sort of really doing your homework and thinking about it, might have a place in your marketing toolbox.
• 9:26
  SPEAKER_00: Is there one so like with WASDA report coming up in May?
• 9:29
  SPEAKER_00: Uh for one, do you like to do it?
• 9:32
  SPEAKER_00: It sounds like more about a week or two weeks in advance of that then.
• 9:36
  SPEAKER_00: And uh do you like to use weekly or did have you has your information led you to uh find greater value in those weekly ones ahead of that uh report time frame?
• 9:47
  SPEAKER_00: Uh can you tell me a little bit more about the findings that you guys have done?
• 9:51
  SPEAKER_01: Yeah.
• 9:52
  SPEAKER_01: Um there's not a clear one size fits all kind of thing, and that's it's sort of the the mixed blessing of having all these different um option expiration uh levels available.
• 10:07
  SPEAKER_01: So, you know, are you trying to position a short-run situation?
• 10:12
  SPEAKER_01: Um we have found it there's similar responses.
• 10:16
  SPEAKER_01: If you're just using a regular nearby uh expiring option, it's not behaving that much differently from a weekly.
• 10:24
  SPEAKER_01: Um, but you've got uh the out-of-pocket, the premium cost is is cheaper generally on the weeklies, for example.
• 10:34
  SPEAKER_01: Um so some of it's just trade-offs there between um premium levels and matching up well with the date.
• 10:43
  SPEAKER_01: Um I think it's I think it's uh sort of a challenge with some of these uh short-dated options is making sure your expiration date is really after uh a major report.
• 10:55
  SPEAKER_01: So I mean right now it seem it seems uh not really confusing, but um you wonder what's going on.
• 11:02
  SPEAKER_01: There's more uh trading volume and open interest in uh in a report that ends right before the June Acre report.
• 11:11
  SPEAKER_01: Well, that's not going to do a hedger much good to not have price protection um that that gets you beyond a major market event.
• 11:21
  SPEAKER_01: So just something to watch.
• 11:23
  SPEAKER_00: Interesting.
• 11:24
  SPEAKER_00: Because uh one thing I've noticed here is uh we like to do a lot of short-dated options ahead of the reports that will expire, you know, a week after or so.
• 11:34
  SPEAKER_00: And uh one thing we've noticed is that uh you'll find a short-dated put, you'll buy it ahead of the report, report will come out, there'll be some volatility ship shape one way or another.
• 11:45
  SPEAKER_00: Um time value erodes incredibly quick right after that report comes out.
• 11:51
  SPEAKER_00: So that's discouraged a lot of people, I've noticed, um, from a time value perspective during those reports.
• 11:57
  SPEAKER_00: Did you find anything out specifically about time value or what how you like to manage it?
• 12:03
  SPEAKER_01: Yeah, I we've got to be very particular here.
• 12:06
  SPEAKER_01: Time value isn't what necessarily is gonna disappear.
• 12:10
  SPEAKER_01: It's the volatility that disappears.
• 12:13
  SPEAKER_01: So you do need to be conscious of the time value because with all these short dated options, they they they go to zero in a hurry.
• 12:21
  SPEAKER_01: Um the weeklies always, the short dated in those last 30 days, the time decay is really rapid, really fast.
• 12:31
  SPEAKER_01: Um so um how we've approached that in the in the trading class, for example, uh is is to stay away from stay away from the nearby that's about to expire, so that expiration month and going out a little further so that you have time for a price to move um without uh giving up all that and sort of handing the volatility over to the to the seller.
• 12:56
  SPEAKER_01: Um and h I don't there's no grand simple answer for for how it plays out, but what you're seeing is probably the volatility falling sharply, especially after you know a a midsummer WASD.
• 13:10
  SPEAKER_01: We've just eliminated a lot of uncertainty in the market that pushes it down.
• 13:15
  SPEAKER_01: So but if you're hedging and you're trying to make a sale, then then you should be um you shouldn't be as concerned about or um angry at the market because five cents or twenty cents dropped in the value of that premium.
• 13:34
  SPEAKER_00: This year's gonna be very important as we look at a lot of strategies here uh going into the summer.
• 13:39
  SPEAKER_00: Maybe we don't have enough corn sold uh going into these higher prices still if we get a weather rally.
• 13:46
  SPEAKER_00: It's gonna be really tough to try to get the book covered that we would like to ahead of some of these reports.
• 13:51
  SPEAKER_00: And being where we're at already on prices, there's a long ways we could go back down to normal or average prices.
• 13:59
  SPEAKER_00: And I think that's short-dated option strategies or weekly option strategies around some of these report days are gonna get looked at quite aggressively from hedgers' perspectives, and rightfully so uh with the amount of um uh vulnerability they have at these current price levels.
• 14:17
  SPEAKER_00: So it's a really nice topic, I think, going into this growing season and something that's uh worth looking at.
• 14:23
  SPEAKER_00: So thank you for your time today, Matthew, and uh any finishing thoughts for our listeners?
• 14:29
  SPEAKER_01: Uh just keep plugging away.
• 14:30
  SPEAKER_01: You know, you can continue to learn about the uh markets in various ways.
• 14:35
  SPEAKER_01: Uh there's always these little subtle nuances like, oh, volatility changed, or the timing of this has changed, um, and you don't wanna you don't want to get lost too far into the weeds and step back every once in a while and say, hey, how does this this change in the market or this change in in the toolkit uh what does that do?
• 14:55
  SPEAKER_01: Does it improve my marketing plan and help me make some some good sound um marketing and risk management decisions uh going forward?
• 15:05
  SPEAKER_00: Thank you for your time.
• 15:06
  SPEAKER_00: And thank you to all our listeners.
• 15:08
  SPEAKER_00: Please reach out to us at professionaleggmarketing.com.
• 15:11
  SPEAKER_00: Check out our other podcast as well, Professional Egg Marketing, that's released every Friday.
• 15:16
  SPEAKER_00: Trading commodity futures and options involves substantial risk of loss and is not suitable for all investors.
• 15:23
  SPEAKER_00: See you next time.