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Know Your Market

RSS By: Dairy Today: Know Your Market, Dairy Today

Dairy trading experts offer strategies and practical perspectives to optimize market performance.

Make Market Volatility Work for You

Oct 31, 2011

Although market volatility can be stressful, financial planning, proactive trading and patience can help ensure a proper risk management strategy is executed for the financial health of your dairy business.  

 
Katie Krupa photoBy Katie Krupa, Rice Dairy
 
Traveling around the country, I talk with many dairymen who are discouraged from hedging their milk on the Chicago Mercantile Exchange (CME) because of the market volatility and the role of speculators in the market.
 
My response to this concern: Yes, there is volatility, and yes, there are speculators in the dairy complex, but that is a good thing for your hedge strategy. The market volatility can enable your financially sound hedge strategy to be executed during upswings in the market. Typically, the most difficult aspects of hedging in a volatile market are to be proactive and patient.
 
Since the beginning of October, the October-December Class III futures price has fluctuated within a range of about $1.30. Early in the month, the October-December Class III average was around $16.50. Then it moved up to $17.70, then back down to $17.00, and most recently it traded as high as $17.83. While this trading volatility can certainly cause heartburn for those watching the market, it also provides opportunity for those actively hedging their milk price.

Krupa to Join Risk Management Panel at Las Vegas Conference


Register now to hear Katie Krupa speak Nov. 8 at Dairy Today's Elite Producer Business Conference in Las Vegas. 

 
 
So how do dairymen use market volatility to hedge their milk? Again, the first step is to create a hedge strategy that is financially sound for your dairy business. The next step is to work with your broker or cooperative to place an order that will trade for multiple days – orders can be active until a certain date, or active until cancel. That means an order will continue to trade daily until the order is filled on the market, the specified date in reached, or the order is cancelled.
 
For example, a dairyman placed an order on Oct. 3, 2011, to sell his milk at $17.50 for October-December 2011, and he set the order up to trade until Oct. 12, 2011 (good until date Oct. 12, 2011). Although the price was only trading around $16.50 when the order was placed on Oct. 3, the price moved up over $1.00 in less than a week. Because the trade was set up to trade until Oct. 12, 2011, the order would have been filled on Oct. 7 when the price traded through $17.50.
 
By creating a strategy that first meets the financial needs of the farm, and then placing the order and allowing the order to trade for several days on the market, the hedge strategy would have been executed. Please keep in mind that an order placed $1.00 above the current market price will not always be executed because the market may not reach those high levels. But in a volatile market where the market frequently moves 20-50 cents per day, placing an order and allowing it to work for multiple days will enable a hedge strategy to be executed if the market moves higher.
 
Each day, the Class III futures price can change up to 75 cents per month (the market is limited to a 75-cent change per day). On some days, the market will first trade higher and then move lower. In theory, the market could move 75 cents higher, then change direction, and move down $1.50 (down 75 cents from the opening trade price).
 
Frequently, dairy producers will check the trading prices once a day at the end of the day. If you are not interested in watching the market throughout the day, you can place your order and allow it to trade for multiple days. If the price reaches your desired hedge price, your order is already working and your hedge strategy will be executed.
 
There are several things to keep in mind when placing an order that will remain active for a period of time. First, and most importantly, your hedge strategy should be established based on your farm’s financial situation. Secondly, any order that is working for a period of time should be re-evaluated on a regular basis. I suggest that all working orders be reviewed on a weekly basis. It is good to touch base with your broker or cooperative to ensure that your order is still working. From a broker’s perspective, I connect weekly with producers to ensure they are aware the trade is still working.
 
Although market volatility can be stressful, financial planning, proactive trading and patience can help ensure a proper risk management strategy is executed for the financial health of your dairy business.  
 
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 klk@ricedairy.com.Visit www.ricedairy.com.
 

 

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