Know Your Market
Is It Too Late to Hedge Milk Prices?
Feb 12, 2012
Put options, feed price management -- there are strategies producers can employ today to protect their price from moving even lower. But also be prepared for when profitable hedging opportunities once again emerge.
By Katie Krupa, Rice Dairy
In recent weeks, the milk market has moved significantly lower, while the anxiety among dairymen across the country is moving significantly higher. Current milk futures prices are below breakeven levels for many dairymen. If this is the first time these producers are looking at risk management strategies, unfortunately their current opportunities aren’t that great.
So what can producers do now to protect themselves? Below are several strategies and thoughts to keep in mind.
Protect your milk price from moving lower. Although the current Class III futures price for March and April isn’t very attractive (currently around $15.60), it is important to keep in mind that this price could move another $2-$4 lower. While this drastic of a drop is not likely, it has occurred before (remember 2009?). Rather than locking in the price and missing out on any possible upside, I recommend buying a put option to protect the price from moving lower. Currently a Class III $15.00 put option can be purchased for about $0.25 per hundredweight for March and April. That would offer net price protection at $14.75 ($15.00 – $0.25) Class III. I know that $14.75 isn’t a price that meets or exceeds break-evens for most dairymen, but this type of price protection should be looked at like catastrophic insurance. Coverage at this level may enable your business to survive if the milk price dropped to $10 or $12 per cwt.
Make sure you are protecting your margin. While it is very important to protect your milk price from moving lower, it is also important to protect your feed prices from moving higher. If you grow most of your feed, you are somewhat insulated from price changes in the feed market – at least until next harvest. For these producers, I typically just try to protect their protein needs. If you purchase most of your feed, typically your feed price is completely unknown 30-60 days out. So what do you do? You may have some hedging opportunities with your feed suppliers that are worth looking into, and you have numerous contracting strategies available through the Chicago Mercantile Exchange (CME). Although hedging on the CME does not provide a perfect hedge, it does provide a good hedge.
Make sure you are prepared for the next price upswing. What will you do if Class III futures rally and move up $2 within the next month? Do you have an account established with a broker, co-op or milk plant? Do you know your breakeven Class III price? We have experienced many milk-price cycles in recent years, but still many dairymen become complacent when the milk price is at a profitable level. They tend to think that the milk price will stay high, or at least stay high enough. While I wish that was true, we both know it’s not. Going back to the insurance analysis – you need to purchase your insurance before the car accident, medical issue or house fire. You can’t get coverage after the incident has occurred. If the milk price is low, at least become prepared for when the milk price is again high. Take some time to talk with risk management professionals and learn more about available risk management strategies.
When establishing risk management strategies, it is very important to be proactive rather than reactive. When the market offers you an opportunity to hedge or protect a profitable margin, take it! For months, we have seen really good hedge opportunities available to dairymen, but sadly many did not take advantage of those opportunities. There are strategies that producers can employ today to protect their price from moving even lower, but my biggest piece of advice is to be prepared for when the profitable hedging opportunities once again emerge.
Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at firstname.lastname@example.org.Visitwww.ricedairy.com.