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July 2011 Archive for Know Your Market

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

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

Zooming In on LGM for Dairy History with Detailed Graphs

Jul 25, 2011

Livestock Gross Margin for Dairy expert Marv Carlson explains a risk management educational tool that helps dairy producers further understand seasonal and other historical price trends. 

Marv Portrait 4By Marv Carlson, Dairy Gross Margin, LLC
 
My goal this month is to explain another of our Livestock Gross Margin (LGM) for Dairy risk management educational tools we think helps producers further understand seasonal and other historical trends. To assist decision making and understanding of previous opportunities, we at Dairy Gross Margin provide a continuation of the chart comparing monthly Expected Gross Margin vs. the Actual Gross Margin started by Penn State University.
 
For a “let’s get started zoom-in analysis” of how the historical monthly margins have settled out, take a look at the 2008 through 2009 chart below.
 
Carlson 7 26 11 chart 1
 
The solid black line is the Actual Gross Margin (AGM) per cwt. of milk. Each of the colored lines with various symbols represents an insurable set of 10 months that was available on the LGM Sales Day (the last business Friday of each month). The first sales day contract shown (maroon line with boxes) is August 2008 with the insurable months of October 2008 through July 2009.
 
How did this insurance contract month settle out? The first two months (October and November 2008 ) show that producers had a better Actual Gross Margin (AGM) than what could have been insured, meaning they had a better cash flow than expected by the LGM for Dairy insurance (EGM, or Expected Gross Margin ). Month Three (December ‘08) AGM was approximated the same margin as the EGM. As you may well recall, things really hit the skids in 2009. Producers who purchased LGM for Dairy insurance for coverage during the fourth through 10th months (January through July ’09) would have had a better cash flow position to the extent of the cwts. of milk insured. Some of the months, as you can see, had indemnity payments in the neighborhood of $5.00 per cwt. of insured milk (with a zero deductible).
 
Carlson 7 26 11 chart 2This chart is a continuation of the previous one. It does overlap some, due to the fact that LGM Sales days will allow the opportunity to buy insurance coverage 10 times for a given month.
 
When an LGM for Dairy indemnity is paid, the total Actual Gross Margin of all months insured will be lower than the total Expected Gross Margin insured. Each month is calculated separately and summed up at the end of the policy period when all the CME and CBOT contract months used for insurance calculations have settled.
 
If you had purchased insurance as shown by the charted months, you would have placed a margin protection floor for the production covered in the monthly target marketings while leaving the topside open. We recommend a balanced or multi-faceted approach to risk management, with LGM for Dairy being one of the tools that will allow a producer to take advantage of upside opportunities for milk while allowing for the opportunity to capture lower feed prices should corn and soybean meal prices decline.
 
The best thing to wish for if you have purchased LGM for Dairy coverage to protect your cash operating or current position is to never have to fill out the paperwork if an indemnity is due.  Why do I say this? I say this because in real life, the milk price probably went up and feed prices probably went down, and you are quite likely experiencing a sigh of relief that things are going your way for a change!
 
The above charts are available for viewing at our website www.dairygrossmargin.com under “Dairy History.” You can print them for further trend analysis. We like to compare the historical price of milk to the actual margin trend. Other analysis tools are available under the same “Dairy History” link.
 
If you want to brush up on how LGM for Dairy works before the fall harvest season gets in full swing, just give us a call or send an email. We would be happy to discuss LGM or set up a webinar. We are also scheduling some September meetings in the upper Midwest. Call us or check the website for dates and locations.
 
Marv Carlson is with Dairy Gross Margin, LLC, in Sioux Rapids, Iowa. Contact him at marv@dairygrossmargin.com or (712) 240-8395. Visit the firm’s website for more information: www.dairygrossmargin.com.

Marketing Needs Your Time Today

Jul 11, 2011

By Steven Schalla, Stewart-Peterson

It turned out to be a beautiful 4th of July weekend in Wisconsin and, for me, it was a welcomed chance to get outside and work on those summer projects!  I’m always surprised how quickly the day flies by when you keep moving, and despite good progress, there always seems to be something left on the list!  I bet you can relate. 

This is why I can easily understand how finding time for marketing can be such a challenge, especially with summer fieldwork taking extra time.  Like other aspects of the dairy, marketing takes a continuous effort to be successful. 

Especially now, with nearby milk contracts at historically high prices, it is critical to find the necessary time for marketing.  

Milk prices look poised for July to be the first month since June 2008 to have a Class III price over $20.00.  While this is a welcomed accomplishment, history shows that these prices do not last very long.  In addition, the corn market has also taken a big step backwards from the early June highs of $7.50/bu for old crop to just over $6.00/bu for new crop on the Chicago Board of Trade.  If weather continues to be conducive to crop development, grain prices could continue to ease into harvest and provide relief for operations that purchase these inputs.  

With potential long-term trends at risk of shifting and summer markets showing their typical volatility, it’s easy to see why taking the time for marketing is more important than ever.  

To be most efficient, we recommend shifting your focus away from market outlook and instead using Market Scenario Planningsm to devise a strategy that will prepare you for whatever the market does.  There are many opinions about how long these price levels can last or how quickly the market could slip.  Regardless, there are many different tools available to help insure your price.  

Market Scenario Planningsm requires time and can be extremely rewarding knowing that you’ve made decisions to protect what you’ve worked so hard to earn.  If it’s challenging to commit this time, we suggest seeking help from a marketing expert.  By finding a trusted advisor, you can save substantial time as they can help you learn the intricacies of the marketing tools and work to find the strategy that best meets your objectives.  Operations with a management team often find this helpful, as the advisor can blend the different ideas and risk tolerances to arrive at a plan everyone can commit to.  This can be very similar to other resources your operation likely uses, such as a nutritionist, A.I. technician, or agronomist. 

  • For the producer that likes to follow the markets and is looking for a sounding board and trade execution source, the traditional broker relationship can be successful.  Look for the right expert who will serve as an information resource as ideas are shared back and forth.  This will make the time you spend on marketing more efficient and productive.  Understand that the level of communication is often driven by the producer, so being proactive is still critical. 
  • For the producer that has less experience with marketing and has little time or desire to learn, seeking a marketing consultant can lead to the best results.  In this relationship, the consultant will learn all the particulars of your operation and tailor a specific strategy to meet the desired goals and objectives.   Communication and strategy ideas are usually initiated by the consultant with feed-back given by the producer.  This frees the maximum amount of time for the producer and still results in meeting your marketing objectivities. 

Based on your interests and the decision process of the management team, either of these arrangements can be successful in providing the necessary help for marketing while keeping your time focused on other tasks. 

As milk prices reach historical highs and the long-term trend comes into question, finding the time for marketing is critical.  To be most efficient with these efforts, our experience shows that using Market Scenario Planningsm can prepare you for whatever the markets presents.  The time is now to embrace the time constraint of marketing to become comfortable and satisfied with your marketing efforts. 

Steven Schalla is a Market Advisor for Stewart-Peterson, Inc. He can be reached at 800.334.9779 or sschalla@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing.  Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2011 Stewart-Peterson Inc. All rights reserved.

 

Using Put Options to Protect Your Milk Price

Jul 04, 2011

Put options offer producers price protection without limiting your upside potential, and producers don’t have to worry about funding margin calls.

 
Katie Krupa photoBy Katie Krupa, Rice Dairy
 
When I talk to dairy producers about risk management, there are two frequent concerns that prevent them from entering a risk management strategy.
 
Firstly, many producers are concerned about contracting milk and missing out on potentially higher milk prices. Secondly, they are concerned about the cash requirement to maintain their margin account if the market should move against their contracted position.
 
By utilizing put options, dairy producers can protect their milk price, not limit their upside potential, and have no margin calls to maintain their margin account.
 
Put options trade on the Chicago Mercantile Exchange (CME) along with futures contracts. Options are a step beyond futures in that a futures contract sets a price, while an option gives the owner the choice of the market price or a pre-determined price. An option has a buyer and a seller – the buyer pays a premium to have the option of getting a set price in the future. The seller of contract collects the premium and provides the price if the buyer wants.
 
Let’s walk through an example to better understand. You’re a dairy farmer who wants to protect your Class III milk price for the month of September at $17.00. The current premium for a September $17.00 put option is $0.30 per cwt. As the dairy producer, you will buy the $17.00 put option for $0.30 per cwt. Each contract is 2,000 cwt. (200,000 lb.). You will buy one contract. Therefore, your total cost for the $17.00 put option is $600 ($0.30 x 2,000).
 
When working with a broker, one needs to pay the premium cost (in this example, $600) upfront when the trade is executed for the put. By paying the premium, the price is protected if the Class III price should fall below $17.00. No matter how low the September Class III price is for the month of September, your price will be $17.00.
 
So, for example, if September’s USDA announced Class III price is $14.00, you will have a margin account balance/credit of $3.00 per cwt. ($17.00 minus $14.00). Since you purchased one contract, the total account balance will be $6,000 ($3.00/cwt. x 2,000 cwt.).
 
Keep in mind you already paid the $600 premium upfront, so your net return will be $5,400. That $3.00 per cwt. in your brokerage account will compensate your milk check price, which will reflect the announced $14.00 Class III price.
 
So, we walked through what happens if the price should drop below our put option price, but what happens if the price should move higher?
 
If you buy a put option and the price goes up, you get the higher price. When buying a put option, you pay the premium, but you will not be limited from upside potential. So, for example, if the Class III price for September is announced at $19.00, your brokerage account balance will be zero, nothing owed and nothing due. But, again, you have already paid the premium of $600. Your milk check will reflect the $19.00 Class III price.
 
Maintaining your margin account by purchasing a put option is simple. Pay your premium upfront. That’s it. You will never have to add more money to the margin account if the price moves higher. In other words, there are no margin calls when buying put options. If the price should move lower, you will actually have a credit in your account.
 
Put options offer producers price protection without limiting your upside potential, and producers don’t have to worry about funding margin calls. Put options can be purchased in 25-cent increments ($17.00, $17.25, $17.50, etc.). The higher the put price, the higher the premium, and vice versa.
 
There are various strategies that can be employed by dairy producers to protect your milk price with put options. Risk management strategies are diverse and constantly evolving. I recommend talking with a professional to determine a strategy that works best for your farm business. Be sure to discuss all your needs and concerns before you enter or dismiss any risk management strategies.
 
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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