Contracts
Hedge and Cash Flow
    Contracts
Commodity Brokerage Services
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Introduction
Strategic Marketing Programs
For Pork Producers

    Pork producers have several alternative methods to market their production. The most common and easily understood is the live cash market. An alternative is selling on a lean carcass basis in order to receive financial benefit for the quality of the animal. These methods depend on a favorable cash market at the point of sale and do not provide for management of risk.

    Some producers attempt to manage price risk through contractual arrangements with packers. Such contracts specify quantity, quality, price or a combination of delivery conditions.

    Still others manage price risk through use of the Futures markets. Pricing tools such as Hedges and Options provide a safety net to lock in profits or to limit your loss.

    Many pork producers are unable to effectively use the Futures system because the contract size does not match their marketing pattern. As an example, a 40,000 pound lean hog futures contract would require a delivery of over 200 head of finished hogs.

    Producers Livestock Marketing Association (PLMA), is able to offer a futures based contract on deliveries as small as 5,000 pounds. This contract will enable the producer to utilize the Futures market as an effective pricing and risk management tool.

    Through PLMA’s extensive network of members, we are able to combine several smaller contracts into a full Futures contract. This unique program is possible through a Hedge Contract between yourself and PLMA.

    Just as with regular Futures hedge, you have the opportunity to gain from your Futures through a stronger basis position at delivery. Your cash market is quality based, so your opportunity for basis gain is greater as you improve the quality of your hogs.

    Your decision process is enhanced by having access to knowledgeable and experienced commodities brokers and marketing agents who are also close to the general market as well as your operation.

    Finally, margin calls are simplified by a single free arrangement designed to cover, not only your brokerage expense, but also the advance of the initial margin and any additional margin calls that may apply to your contract until cash market time.

    What could be easier - One Call, One Fee, One Experienced Consultant!


Programs
Producers Livestock Marketing Association
Risk Management Alternatives In The Pork Sector
Prospectus

WE WOULD LIKE TO INTRODUCE A UNIQUE RISK MANAGEMENT PROGRAM FOR PORK PODUCERS.
BUT FIRST, WHO ARE "WE"?

    Producers Livestock Marketing Association (PLMA) is a bonded livestock marketing cooperative. We provide marking, credit and commodities brokerage services throughout Iowa, Nebraska, South Dakota, Minnesota, Kansas and Missouri. PLMA has been in existence for over 60 years. Financial information will be provided on request prior to entering into any marketing agreement.

THE NEED!

    Many pork producers do not have the size of operation to enable them to use effective, independent risk management alternatives such as the futures market. This often pushes them to accept a long term contract with a local packer which, as many have learned, may create a significant liability during periods of depressed prices.

    In addition, it is often not wise to lock in all production reducing all opportunity for the upward movement of prices or limit the market to a single buyer.

    PLMA, through a unique marketing structure, is able to provide an opportunity for pork producers to use the futures market for contracts as small as 5,000 carcass pounds. In addition, this program will eliminate the need for you to make "margin calls" associated with the futures market.

PROGRAM OBJECTIVE:

TO ENABLE A PORK PRODUCER TO UTILIZE THE FUTURES MARKET FOR PRICING OR RISK MANAGEMENT PURPOSED AT QUANTITIES LESS THAN THE MINIMUM CONTRACTS STANDARDS OF THE MARKET; TO PROVIDE FOR PAYMENT OF INITIAL AND MAINTENANCE MARGIN REQUIREMENTS THROUGH A SINGLE SERVICE FEE AGREEMENT.

HOW DOES IT WORK?

    Through a Hedge Contract, PLMA is able to combine several small contracts into a single futures contract. A single contract fee, based upon the length or term of the contract will cover the brokerage charges plus the initial margin and maintenance margin advances made in your behalf.

    When the hogs are sold and delivered to a packer of your choice, PLMA will close out the contract and add or deduct and futures gain or loss.

    Since the cash market portion of this transaction is a vital part of the overall futures net return, PLMA is also available to provide cash marketing and pricing services.

NET CONTRACT PRICE.

    The producers will receiver the value of his actual cash or grade & yield sale, plus or minus the hedge contract profit or loss. A contract profit during a lower market will help offset the lower cash or grade & yield market price. Regardless of market direction, this will allow the producer to realize the return estimated at the time the contract is written. Any price adjustment will be due to the actual basis at market time.

BASIS RISK

    The basis risk associated with the futures market pricing mechanism is born by the pork producer.

    Basis is defined as the difference between the cash or grade & yield market price and the current nearby futures price.

    Contracts are priced at the futures board price with the net expected value adjusted by historic basis tables. The actual basis difference could be greater of less, depending on market conditions at the time of delivery. The cash price for determining basis will be the actual value based cash price at delivery. This enables a producer of high quality hogs to realize better net value by exceeding the quality assumptions used at the time of pricing. (SEE NEXT SECTION FOR COMPLETE EXPLANATION OF "BASIS".)

WHAT DOES IT COST?

    An up-front fee is charged based on the estimated close out date of the contract.

CLOSE OUT DATE
6 months or less
over 6 months
 		PRICE/CWT.
$0.50/cwt.
$0.75/cwt.

WHAT DOES THE PRODUCER NEED TO DO?

  1. Complete a marketing agreement that specifies the conditions and basis risk factors and establishes the maximum number of contracts expected during the agreement period.
  2. Inform the primary lender of the agreement conditions.
  3. Advise the primary leader that the sale proceeds will be processed through the PLMA offices to be adjusted by hedge gains or losses and then forwarded with the appropriate lien holder identification.
  4. Provide a description of their operation and a current balance sheet (or have one provided by the lender).

WHAT HAPPENS NEXT?

    When a producer decides to place a contract, a Hedge Contract showing the contract month & year, number of pounds contracted, futures price, service fee cost and expiration date of the underlying futures contract will be generated and forwarded to the producer and the primary lender (if requested). Payment of the fee is to be remitted by the producer or the lender to PLMA’s office. The producer will be given a buyer’s notice and authorization form prior to delivery to be presented to the packer when the hogs are delivered to assure that the packer will forward the proceeds to PLMA.

HOW DOES THE CONTRACT CLOSE OUT?

    When the hogs associated with the contract are finished and priced or delivered to a packer, the producer is to advise the PLMA office to close out the hedge. The proceeds of the sale will then be remitted to PLMA by the packer, where PLMA will add any futures profit or deduct any futures loss and remit the balance of the proceeds to the customer of primary lender with the appropriate lien holder identification.

SUMMARY.

    The ability to utilize the futures market is a sound risk management tool. Often, an individual may not want nor need to lock in 100% of production, thereby limiting the use of the futures market as a pricing or risk management alternative. Use of the futures market for a smaller quantity can be a valuable alternative to long term contracts. The Hedge Contract enables the producer to selectively use the futures market to the their advantage. In addition, the producer has access to experienced, salary based brokers in the decision process.

    The primary lender is protected by knowing exactly what portion of the producers’ total production is under risk management and also not be burdened with processing margin calls on behalf of their borrower. This risk management protection can enhance the lending relationship between producer and lender.




CASH FLOW CONTRACT.

    In some instances, pork producers would hedge only those months that reflected the highest futures price, skipping the lower priced months, which often times were the months that needed to be hedged most of all. By averaging multiple futures contracts into a single price, the Cash Flow Contract can provide cash flow stability and potentially a price level that is profitable for an extended period of time, from 4 to as much as 14 months into the future. You are paid based on that average price for each delivery. The premiums you receive from the packer are still yours. You stand the basis gain or loss.

    What you’re doing with this contract is hedging your pork on futures exchange and then balancing the hedge against the average of those prices at delivery time. This provides you price protection and cash flow stability. It also enables you to ship hogs to any packer with the added flexibility of changing the packer you deliver to, even in the midst of the contract delivery period - without any penalty. You just need to deliver a consistent amount of pork each month. The mechanics and fees are the same as outlined above for the Hedge Contract.

BASIS LEDGER AGREEMENT.

    This is a unique add-on benefit exclusive to the Hedge Contract or Cash Flow Contract. In addition to the features, benefits and process outlined above for the Hedge Contract and the Cash Flow Contract, the Basis Ledger Agreement provides for basis stabilization over the contract delivery period.

    Working with you, a PLMA representative helps to calculate the average historical monthly basis (the difference between the futures contract and cash price you receive for your hogs on the day delivery) for the contract period. This basis projection in combination with the prices hedged will provide the price base on which you will be paid for each delivery made under the Agreements.

    During the delivery period a ledger is maintained that keeps track of the difference between the actual basis what was realized on yours hogs versus the one that you were paid. At the end of the delivery period, the ledger is balanced. If you were advanced more money than the actual basis provided, you pay PLMA the balance. If you were paid less than the actual basis, PLMA pays you the difference.
    This is a program designed to add additional stability to the your cash flow by taking the peaks and valleys out of basis fluctuation. There are no special fees associated with program. One difference with the Basis Ledger Agreement is that you are required to utilize the nearest PLMA marketing agent when marketing your cash hogs, and pay the normal selling commission. As always, they will be marketed to the packer where your hogs perform the best, and the premiums are yours. Our interest in offering this program is to add additional price stability to your operation.

HEDGE CONTRACT USING OPTIONS?

    Yes. It’s easy and convenient. You can use Lean Hog Put and Call Option in 40,000 lb. increments and PLMA will finance those costs under the same Hedge Contract agreement. Buy Put Options for your downside price insurance, or establish a "fence" (buy put/sell call), and PLMA will finance the out of pocket option premiums and any margin calls associated with a "fence" transaction. From there, the mechanics are the same as previously outlined for the Hedge Contract. The fees are: Buy Put Options = $0.30/cwt.; Sell Call Options = $0.50/cwt, paid up-front.

Commodity Services.

    If you’d rather have your own commodity account and work with an experienced commodity broker that’s a livestock industry specialist, we can help you with that too. Producers Commodity Services have brokers that are salaried and not commissioned. Their interest is in helping you with your marketing program.

    Our extensive marketing network - PLMA members, marketing representative, nation affiliates and contacts involved with the livestock, grain and feeds markets everyday - provides reality-based analysis of present markets and futures trends, tempered with close understanding of the members marketing needs and concerns.

    Producers Commodity Services has experienced professional commodities staff available to work with you in developing price protection and marketing strategies. In addition, the staff is available for education and informational outlook meetings.




BASIS


WHAT IS "BASIS" AND HOW WILL IT EFFECT YOUR FINAL RETURNS?


    When your hogs have reached market weight, you will sell your hogs on the open market just as you would have done if they weren’t contracted. So you must do a good job marketing your hogs. But when you get a bid, don’t commit your hogs until you compare your estimated net price (after premiums) with the current futures quote. The difference between your cash price and the current futures price is called "BASIS". This difference is very important to you when calculating the net price you will receive for your hogs. Let’s look at several examples.

EXAMPLE 1:

Suppose your contract price for April delivery is $60.00. It’s now market time and you are bid $55.00 by your local packer. That same day the April Futures are trading at $55.00. Basis is calculated as CASH MINUS FUTURES, so in this example the basis = $0.00. You will net $60.00 for your hogs. Why??

  1. You hedged them at $60.00 and got out at $55.00, realizing a $5.00 futures profit, which we will add to your cash hog check.
  2. You sold cash hogs at $55.00
  3. $55.00 cash sale + $5.00 futures profit = $60.00 net - the same as your original Hedge Contract price because of the $0.00 basis.

EXAMPLE 2:

Suppose your contract price for April delivery is $60.00. It’s now market time and you are bid $53.00 by your local packer. That same day the April Futures are trading at $55.00. Basis = minus $2.00, which means you will net $58.00 for your hogs. Why??

  1. You hedged them at $60.00, and got out at $55.00, realizing a $5.00 futures profit, which we will add to your cash hog check.
  2. You sold cash hogs at $53.00.
  3. $53.00 cash sale + $5.00 futures profit = $58.00 net - less than your original Hedge Contract price because of the minus $2.00 basis.

EXAMPLE 3:

Suppose your contract price for April delivery is $60.00. It’s now market time and you market you hogs grade & yield. You estimate from past performance that your final grade & yield price (after premiums) will be $56.00. That same day the April Futures are trading at $55.00. Basis = plus $1.00, which means you will net $61.00 for you hogs. Why??

  1. You hedged them at $60.00, and got out at $5.00 futures profit, which we will add to your cash hog check.
  2. You sold cash hogs at $56.00 (grade & yield).
  3. $56.00 cash sale + $5.00 futures profit = $61.00 net -- $1.00 more than your original Hedge Contract price because of the plus $1.00 basis.
In the first three examples, the underlying hog market (cast & futures) went lower after you hedged your hogs. What would happen if the hog markets were to rise after you contracted?? Let’s look at three more examples.

EXAMPLE 4:

Suppose your contract price for April delivery is $60.00. It’s market time and you are bid $64.00 by your local packer. That same day the April Futures are trading at $64.00. Basis =$0.00, which means you will net $60.00 for your hogs. Why??

  1. You hedged them at $60.00, and got out at $64.00, realizing a $4.00 futures loss, which we will deduct from your cash hog check.
  2. You sold cash hogs at $64.00.
  3. $64.00 cash sale - $4.00 futures loss = $60.00 net - the same as your original Hedge Contract price because of the $0.00 basis.

EXAMPLE 5:

Suppose your contract price for April delivery is $60.00. It’s now market time and you are bid $62.00 by your local packer. That same day the April Futures are trading at $64.00. Your basis = minus $2.00, which means you will net $58.00 for your hogs. Why??

  1. You hedged them at $60.00, and got out at $64.00, realizing a $4.00 futures loss, which we will deduct from your cash hog check.
  2. You sold cash hogs at $62.00.
  3. $62.00 cash sale - $4.00 futures loss = $58.00 net -- $2.00 less than your original Hedge Contract price because of the minus $2.00 basis, but equal to your expected net.

EXAMPLE 6:

Suppose your contract price for April delivery is $60.00. It’s now market time and you market your hogs grade & yield. You estimate from past performance that your final grade & yield price (after premiums) will be $65.00. That same day the April Futures are trading at $64.00. Basis = plus $1.00, which means you will net $61.00 for your hogs. Why??

  1. You hedged them at $60.00, and got out at $64.00, realizing a $4.00 futures loss, which we will deduct from your cash hog check.
  2. You sold cash hogs at $65.00 (grade & yield).
  3. cash sales - $4.00 futures loss = $61.00 net -- $1.00 more than your original Hedge Contract price because of the plus $1.00 basis.

Again, the hog producer in the last example came out the best because of the way hogs were marketed.
Now, after 6 examples, you are probably really confused. What does all this mean - down market, up market, $0.00 basis, plus $1.00 basis, minus $2.00 basis?

SUMMARY:

down market -- $0.00 basis - net $60.00
up market -- $0.00 basis - net $60.00

down market - minus $2.00 basis - net $58.00
up market - minus $2.00 basis - net $58.00

down market - plus $1.00 basis - net $61.00
up market - plus $1.00 basis - net $61.00

The point we are trying to make is this: it doesn’t matter whether the market goes up or down after you have hedged your hogs. The actual basis at market time will determine the net price you will receive.

Basis levels will vary from month-to-month, but can be somewhat predictable, as history can tell us what to expect for any month throughout the year. We keep basis records as for back as 10 years, but look more closely to the last 5-year average. We rely on this average when we explain our Hedge Contract, as we try to estimate what you can expect to receive for your hogs. There will be some basis risk, but much less risk than open market risk You can reduce some of that risk by comparing your cash price at market time with the futures quote. Like we said earlier, don’t commit your hogs until you have made that comparison. Market your hogs when the basis is acceptable.

Please look this over and call if you have any questions. Most importantly, please call when you have hogs ready to market. We would like to have the opportunity to go over this with you again, so we can avoid any misunderstandings.