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Hedging Is Part of Our Plan

November 26, 2013
 
 


Nick Vande Weerd

Nick Vande Weerd

Brookings, S.D.

The Vande Weerd family is majority owner and manager of Pleasant Dutch Dairy, which milks 1,400 Holsteins.

 


Risk management has become more crucial in the last few years as feed and milk prices have become more volatile. This increase in volatility provides an environment for both larger and smaller margins.

There are several ways to reduce price risk exposure. Forward-contracting or hedging using your processor or the Chicago Mercantile Exchange (CME) are two avenues for reducing milk price exposure. In addition, there are several areas that price risk exposure can be reduced. Besides reducing milk price exposure, feed price exposure should also be considered.

Both have pros and cons, and we have used both in the past.

The great part about using our milk processor to forward-contract milk prices has been that they don’t require margin money. In exchange for not requiring margin money, they charge a flat fee to forward-contract with them. But the fee will normally exceed the interest that would be paid on money needed for margin. In addition, our processor will let us hedge milk up to one year into the future.

When we use the CME to hedge, we have used both futures contracts and options. In theory, we can hedge further than a year into the future using the CME, but it can be difficult to get your orders filled because of lack of volume in the further-out months. One advantage of using our broker versus our processor has been we can get orders filled during trading hours, unlike with our processor, who only fills orders in the mornings.

Also, using options can give us flexibility in a hedging program. There are numerous option strategies, but you don’t get something for nothing. When using options, the greater the reduction of price risk exposure or the greater potential gain, the greater the cost will be. We have some risk-management strategies work well and some not so well. Sticking to a well-thought-out plan seems to work the best.

A good risk-management plan should include reducing price exposure to feed. We hedge milk and feed prices independently of each other, but we don’t like to keep them too independent. If we hedge a lot of feed or milk in any particular month, in the near future, we will hedge the opposite one for that month. Hedging one side—feed or milk—without the other can still allow for a reduction in income-over–feed-cost margin. Our goal in hedging has been to try to protect larger income-over-feed cost margins. We have not always achieved this goal.

We have used several tools in risk management. All tools can work well if used with a well-thought-out risk-management plan. We have found that plan should include hedging feed prices in addition to milk prices. Even the best plan won’t work as intended if not executed correctly.

Vande Weerd’s recent prices

 

Milk

$20.10 (3.5 bf, 3.05 prt)

Cull cows

$65-$85/cwt.

Springing heifers

$1,400-$1,675/head

Alfalfa hay (milk cow)

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