Derrell Peel Oklahoma state University

Publish Date: June 3, 2006

Most pork producers are familiar with insurance. Producers insure buildings against fire, equipment against accidents, and their lives against death or injury. Insurance buyers trade a small but certain loss by paying an insurance premium to guard against the possibility of a large but uncertain loss. In pork production, one of the greatest risks faced is that of unfavorable price change. Market hog prices have been so uncertain that many times prices expected to be profitable when decisions were made regarding facility investment, breeding or feeder pig purchases ended up unprofitable instead. Additional risk also may be incurred on the feeding side as feed price increases and may wipe away anticipated profits. Because of these risks, producers might want to insure against unfavorable hog or feed price moves while retaining their ability to profit from favorable price changes. Producers have this opportunity by using the commodity options market.

Publish Date: June 3, 2006

A pork producer who is not familiar with futures markets and hedging may have many questions regarding how to use this pricing tool. But the most basic question is: why be interested in learning about futures markets? In other words, why do producers hedge? To answer this question, it is first necessary to define futures markets and hedging. A hog futures market establishes prices for hogs that will not be delivered until some time in the future. A producer who uses the futures market to forward-price hogs before delivery is hedging. There are two basic reasons to forward-price hogs. First, the producer may feel that current futures market prices are higher than cash prices will be when the hogs are ready for delivery. Second, a producer may be unable, or unwilling, to accept the risks of prices lower than the current futures price, even though cash prices may be higher at delivery time.