A commodity trader’s view on why you don’t want to leave your milk price to chance.
By Chris Robinson, Top Third Marketing
If you can’t answer that question, you are not alone. After working as a trader and a risk manager in commodities for the past 25 years, it’s always surprising when I ask producers that question and they insist they are producers, period. They spend hours and hours factoring their inputs, looking for the most efficient ways of maximizing production, and using their years of experience to do the best job of reaching their goal of producing a quality product.
Failing to plan for a hedging program for your business risk leaves a tremendous amount to chance and the vagaries of the market.
Over the past year, I have written several articles about the price risk in these markets. The spread for dairy growers had gotten very profitable, with Class III milk prices in June trading up to 19.62. Here we are six months later, and, just four days ago, the January contract fell to 15.50. That $4.10 difference translates to 21% drop in value. If you had failed to hedge, you sat and watched every dollar of profit cut by 20 cents.
Conversely, corn, wheat and meal prices as late as September had been at 4½-year lows. We just watched corn rally 80¢/ bushel, wheat rally $1.70 per bushel and soybean meal rally from $292 up to $380/ton in the space of six weeks. What is the point of looking back at these price moves at this point? After all, hindsight is always 20/20. What could producers have done to protect themselves, without opening themselves up to the dangers of over speculation?
From a risk manger’s perspective, if you want to avoid margin calls once your protection is in place, a long option strategy allow you to have your business protection in place within a defined time frame for a defined, finite amount of capital.
For your unpriced production, wouldn’t it have been nice to have a floor up at $18 in the Class III milk in place over the last three months? Again, with hindsight being perfect, a producer could have established a floor at 18 to protect against the recent sell-off.
Conversely, if Class III milk ran higher and had continued its rally through $19.50 and above, a producer would have been able to realize that profit in the physical cash market. If you had used a long put option strategy, that put premium you paid for that option would have evaporated, but you would have been compensated by being able to sell your physical product higher.
For your feed inputs, the converse strategy applies. If you would be hurt by higher input prices with feed, you would want to own a call option as protection against that business risk. This strategy works if you pay your premium and the cash market rallies. As the cash price rallies, so does the value of the call option purchased. The key with a long option strategy is that you know from day one the maximum financial loss on the price of that option from day one.
Utilizing options like this is, in our opinion, the most cost effective way to protect against price fluctuations in these markets which might negatively impact your bottom line as a producer.
Farming, ranching and dairy production can be cash-intensive businesses. It makes sense to do some marketing risk management to protect your business risk as opposed to just hoping for the best.
At the end of the day, if you are a dairy producer, your risk is the same as a speculator who decides to own Class II milk. You own physical milk. You are hoping for higher prices. Rather than have a marketing plan based solely on hope, it makes sense to some risk management. Utilize the tools available to you to limit your financial risk due to volatile markets. Risk management is what separates a producer from a pure speculator.
Chris brings over 23 years of experience to his Top Third clients. He began his career as a broker and analyst in 1991 with a Chicago firm which specialized in cash grain trading and hedging. In 1992, Chris became a member of the CBOT. He joined Top Third in January 2010, capping an 18 year career as a floor trader and broker. Today, in addition to his Top Third duties, Chris is a featured grain and livestock analyst for the CME. He is also featured on weekly video summaries with RFDTV. In January of 2013, Chris became the lead broker for the Pit bull division of Top Third. This is a separate branch of the company that is involved with traditional speculative trading and is separate from the hedging arm of Top Third. Chris is a 1988 graduate of Colgate University with a degree in Political Science and Economics. Contact him at firstname.lastname@example.org.
This material has been prepared by a sales or trading employee or agent of Top Third, and is, or is in the nature of, a solicitation. This material is not a research report prepared by Top Third's Research Department. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions.