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November 2013 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.

How Dairies Can Use Short-Dated New-Crop Options (SDNCO)

Nov 22, 2013

Concerned about rising feed costs in the fall of 2014? Here are examples of these short-term alternatives to trading new-crop corn, soybeans and wheat.

ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin, LLC

The CME Group started offering short-dated new-crop options in June 2012 for corn, soybeans and wheat. These are short-term alternatives to trading new-crop corn, soybeans and wheat. Simply stated, they are options that expire earlier than traditional options.

Traditional options for December corn would expire in late November. The short-dated options now are available for March, May, July and September. So, the options will expire in the last part of February, April, June and August. Traditional options for November soybeans expire in October. Just like corn, the short-dated options in soybeans can be traded in March, May, July and September. Expiration is also sometime in the end of the previous month.

How would a dairy producer use SDNCO options?

If you are concerned about rising feed costs for the fall of 2014 and early 2015, you could buy a SDNCO July or September call option. If there is a weather market in the summer, you may be able to capture some the gains. The profits from the option could be used to lower your feed costs in the last quarter of 2014 and first quarter of 2015. Remember, the July SDNCO option will expire in late June, and the September SDNCO option will expire in late August.

This is an example of a way to protect the cost of silage that you purchase. Buy a September SDNCO $4.60 call that expires in late August for about $.35/bu. If corn is above $4.60, you will have value in the option to pay for the higher-cost silage. If December corn is below $4.60, the option will be worthless, but you will be able to buy the silage cheaper.

Some farming operations and dairy operations try to do business as separate profit centers. SDNCO’s are a simple way to market your corn and then transfer the corn to the dairy operation in the fall.

If you buy a July SDNCO or a September SDNCO put, you will be putting in a floor price for the corn you grow. The September $4.50 SDNCO put can be purchased for $.34/bu. If December corn is below $4.50, you will have value in the option. At that point, you can sell the corn or silage to the dairy operation. If corn prices are above $4.50, you will sell the corn to the dairy operation at the higher price.

SDNCOs could be used to hedge the value of the crop insurance price that is established in February.You would simply buy a SDNCO March corn put that expires in late February. If prices move lower, you can use the gains from the option trade to enhance your February crop insurance price. If prices move higher, the option will be worthless but the February crop insurance price will also be higher.

Corn Comment

In the November report, the USDA reduced Chinese feed grains (corn) use for industrial purposes—basically starch and ethanol. This increased stocks by about 500 million bushels in the world. USDA did not increase Chinese feed use. Industrial production decreases could be because of a slower economy or government pressure to make sure adequate feed supplies are available.

For the U.S., the USDA did increase increased corn feed/residual use and exports.

The November estimated corn yield was 160.4 bu. per acre. The record yield was 164.7 bu. per acre in 2009. This report did show record total production at 13.989 billion bushels vs. the last record of 13.1 billion bushels in 2009. The large crop size came in spite of a reduction of 1.9 million planted acres from the last report. Record corn yields were reported in Illinois, Indiana, Ohio, Michigan, Pennsylvania, Kentucky, Tennessee, North Carolina, South Carolina, Virginia, Georgia, Alabama, Mississippi, Louisiana and Arkansas.

In December, the USDA will release a supply/demand report, but it typically has little impact. On Jan. 10, 2014, the USDA will release stocks, final crop size and the supply and demand balance sheets. With so much data, the January report has proven to be a market mover in the past.

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Reach him at or visit

Know How Your Risk Management Plan Will Impact Your Business

Nov 18, 2013

You should be able to easily see what you’re investing into a risk management strategy and what you’re getting in return.

Katie Krupa photoBy Katie Krupa, Rice Dairy

Recently I was talking with a dairy producer who had used risk management in the past but was displeased with his results. With some further discussion of his past hedge strategy, I realized that he wasn’t sure what exactly he had done and, more importantly, he had no idea what type of protection he had for his dairy business. He had essentially put money into risk management program with no understanding of the level of protection he was receiving. He, like many producers, had a hard time understanding the tangible benefit of the risk management strategy he utilized.

This is something that should be addressed to every producer when he or she is establishing a risk management program. Whenever you invest time and money into something, you should know what you are getting.

With dairy risk management, that becomes more difficult since there are many moving pieces to the puzzle. The general idea is that producers should be able to easily see what they’re investing into a risk management strategy and what they are getting in return. For example, a $0.25 premium cost for an options strategy may protect your Class III milk price at $17.00 on the downside. This is a very important start to understanding your strategy.

But it’s only a start. It’s good to take this to the next level to understand what a $17.00 Class III price means for your business’s income. Adding in your production costs and your potentially hedged feed ingredients will enable you to see your potential profit per cwt. Therefore, the $0.25 per cwt. investment that’s protecting Class III at $17.00 may be protecting an anticipated profit of $1.00 per cwt.

The concept may sound simple: Understand the per-cwt. projected profit margin (or even limited loss) you are protecting with your risk management plan. But unfortunately this is rarely done. Most producers do not utilize a risk management program that allows them to see what they are protecting (profit/loss potential), and then the ability to go back and historically review their results.

Many producers would benefit from using a program/broker/consultant that provides an easy-to-read, risk-management plan analysis. What I mean by this is that many producers don’t have the ability to do a sensitivity analysis on their risk management plan. That includes the ability to review your risk management plan and ask, "What if milk price drops to $14, or increases to $22? How will that impact my bottom line?"

Having a model on paper will ideally make your risk management decisions easier to make because you can easily see the financial impact of the strategies you are reviewing. Additionally, many producers tend to get caught up in the amount of money they "spent" on their risk management program rather than the amount of coverage they received. Having a program that will show you how much money you invested into your risk management plan and how much coverage you had in return will theoretically make your decisions easier, and make you feel better about your decisions after the fact.

While not all producers need a detailed program to understand the long-term benefit of the risk management programs they are using, many producers find an easy-to-read analysis helpful to their understanding of their risk management program. I recommend finding a broker and/or program that can provide you with detailed enough information for you to comfortably make your risk management decisions. Also, I would periodically suggest going back and reviewing how your employed risk management plan performed. Did you get enough downside protection? Did you get enough of the upside potential of market? Was your actual milk price received what you expected and did it satisfy the financial needs of your business?

When working with risk management, it’s not about more information. It’s about more useful information. Understanding how your risk management plan impacts the financial strength of the business is crucial for your business and your future success using risk management programs.

Katie Krupa is a broker with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. You can reach Katie at There is risk of loss trading commodity futures and options. Past results are not indicative of future results.

Managing Class IV Opportunities

Nov 07, 2013

No one can be certain how long the bull market in milk powder may last, but if history is any guide, this appears to be an opportune time to capture some of the price and margin opportunity.

By Will Babler, Principal
Atten Babler Commodities LLC

Dairy producers focus most of their hedging efforts on mitigating collapses in milk prices or collapses in margins. At more fortunate times, they can turn their attention toward capturing price or margin opportunity. One such opportunity is currently presenting itself in the Class IV milk market.

Babler graph 1   11 7 13 copy
Figure 1 – Class IV Futures Prices At or Near Historical Highs

Following a year of short global production, and continued strength in demand for milk powder products, the Class IV market has moved near all-time highs in the front months while the forward curve is also at or near seasonal all-time highs. These price levels can be seen in Figure 1.

The current rally in dairy has been restricted to nonfat dry milk and consequently Class IV. Through October, the remainder of the complex has actually seen a decline in recent prices compared to the prior year. Figure 2 shows the relative outperformance of nonfat dry milk and Class IV.

Babler graph 2   11 7 13 copy
Figure 2 – Price Increases in Nonfat Dry Milk

Class IV vs. Class III Prices

As Class IV prices have increased, there has not been a corresponding increase in the Class III market. This reflects a difference in the supply and demand fundamentals of the underlying products – butter and powder for Class IV and cheese and whey for Class III. Historically, the Class IV price has traded at a discount to Class III. In the last 10 years, the Class IV price has traded at a premium to Class III in only 34% of the months. On average, this premium has lasted five months, with the premium lasting at most 16 months from March 2010 through June 2011. In only 18 of months over the last 10 years, or about 15% of the time, has the Class IV price traded at a $1/cwt. premium or more to Class III. November 2013 will be the fifth month in a row of such premium in the current Class IV bull market. Figure 3 shows the current price premium of Class IV over Class III is at or near record levels and far from the average discount.

Babler graph 3   11 7 13 copy
Figure 3 – Class IV vs. Class IV Price Spread

Class IV Utilization Rates

Current national utilization rates (ex-California) of milk for Class III and Class IV are 48% and 6%, respectively. Since 2000, the Class III utilization rate has ranged from 9% to 49% with an average utilization rate of 40%. The Class IV utilization rate has ranged from 5% to 22% with an average utilization rate of 10% throughout the same period.

Even though this USDA data excludes California, a major participant in the nonfat dry milk and butter market, it is still useful for understanding the potential swings in production. See Figure 4, which details the seasonal trends in Class IV utilization. This seasonal chart shows that Class IV utilization dropped off in the second half of the year compared to a year prior. It also shows that utilization levels could increase significantly if they move back toward their 10-year highs, especially on a seasonal basis as we move forward from this point in the current marketing year.

Babler graph 4   11 7 13 copy
Figure 4 – Seasonal Class IV Utilization

To the extent that one product is carrying a greater value compared to the other, we would expect some switching in manufacturing utilization, or possibly some build-out of new capacity. As this switching or capacity expansion occurs, the supply of the scarce product should increase while the availability of the abundant product should decrease. This should put pressure on the price spread to converge toward the normal relationship. Historically, a tendency toward mean reversion in the price spread and utilization spread has occurred. Figure 5 shows that both the price spread and utilization spread have moved significantly away from their average. While we don’t know how long it will take, it is likely that these both normalize over time.

Babler graph 5   11 7 13 copy
Figure 5 – Class IV Price Spread and Utilization Spread

Demand Destruction

The old adage that high prices cure high prices should temper some enthusiasm with regard to powder and Class IV prices. It is difficult to forecast the timing and the extent of demand destruction that high prices can bring, but a quick look at past history shows that the market has only tolerated prices north of $20.00/cwt. for Class IV for 11 months in the last 10 years, or less than 10% of the time. The dairy products market has a long and complex supply chain. This complexity continues to increase alongside the increase in U.S. dairy exports. We don’t know how long the international markets can remain strong, but we should at least proceed with caution if the past history shown in Figure 6 is any guide.

Babler graph 6   11 7 13 copy
Figure 6 – Short Lived Class IV Price Peaks

Corn price, as a rough proxy for feed costs, shown in the Figure 6 also indicates a further force of gravity that could serve to pull down milk prices. Note that high prices in corn have served to cure high prices in that market. Also note that the prior $20.00/cwt price extreme in Class IV milk was in part tied to high prices in feed.

Hedge Considerations

No one can be certain how long the bull market in nonfat dry milk, skim milk powder or whole milk powder may last, but, if history is any guide, this would appear to be an opportune time to capture some of the price and margin opportunity that is presented through extreme Class IV prices. Each producer should consider his or her risk tolerance, profit margin and financial capacity before pulling the trigger. Now is a good time to review these factors and take action.

Contact Will Babler at

Risk in purchasing options is the option premium paid plus transaction. Selling futures and/or options leaves you vulnerable to unlimited risk. Atten Babler Commodities LLC uses sources that they believe to be reliable, but they cannot warrant the accuracy of any of the data included in this report. Past performance is not indicative of future results. The author of this piece currently hedges for his own account and has financial interest in the derivative product mentioned within: Class III & Class IV milk, butter, cheese, whey and nonfat dry milk.

Amid the Noise of Dairying, Focus on the Matter at Hand

Nov 04, 2013

Seven tips for hedging your milk.

Kurzawski photo 2013By Dave Kurzawski, FCStone

Traders at Chicago’s futures and options exchanges have often told me the term "trading pit" is an appropriate name for where they work. Pushing, shoving, sweating and yelling while trying to concentrate on prices and orders sounds like the pits to me. Say what you will about working conditions, these people do have an uncanny knack for excluding the noise and focusing on their current situation right in front of them. They find order in the chaos.

There is another place we see a lot of chaos right now – the U.S. dairy farm. Still-high overall feed costs and tight lending, among other hurdles this year, have producers around the country up against the ropes fighting for their livelihood. But amid the turmoil, producers ought to take a cue from the guy in the colorful trading jacket. Find order in the chaos.

Part of finding order is to boil down the sum of your business into manageable parts and focus on those parts one at a time. Most of those parts you’ve worked on since you started dairying years ago. They are critical matter of your dairy, the guts of the operation that keep it going every day. Most importantly, they are second nature to you.

But an equally important piece to your business – the one that causes the most agitation for some – is hedging. Now that the cheese and NFDM prices are trading in the high $1.80s to low $1.90s, and the corn market is making three-year lows, it’s time to refocus some energy in the direction of profit-making for the dairy. In all the commotion, ask yourself the question: How do I hedge my milk?

1. Educate yourself. There are many different strategies, but only a few that will suit your personality. Take some time to learn what those are and stick to what you’re comfortable with.

2. Know your cost of production. Before you lock in a portion of your income, you have to have a handle on what it takes to produce a hundredweight of milk.

3. Look at Milk and Feed. Be aware that risk-management tools have fixed contract sizes. One milk contract is the equivalent of 200,000 lb. of milk. A corn contract, for example, is the equivalent to 5,000 bu. of corn. Multiple contracts will likely be needed to protect milk prices and feed cost.

4. Decide on a strategy. Every dairy is different and, though it seems like all producers are in the same boat, most producers have a different risk tolerance level. How much price volatility can you live with?

5. Talk to your bank. You wouldn’t neglect to tell your bank that you added 200 cows, so don’t neglect to tell them of your plans to use risk-management tools to ensure profitability. Plus, there is a cost involved in risk-management and you will need your lender’s assistance in covering them.

6. Take the emotion out of your decisions. A change in feed rations may take months to expose itself as a good or bad decision. Markets are in a constant state of flux, margin calls can be a part of the program, and producers may fret over unrealized hedge losses. They lump them into the "bad decision."

7. Keep it consistent. One of the problems that plague hedgers is that they’re not consistent with their hedging activities. They leave money on the table by hedging one year so they do nothing the next, and that next year they end up losing because they weren’t hedged. If you have a plan to hedge 40% of your milk one year, do the same (when profitable margins present themselves) the next.

Whether you decide upon forward contracting directly with your co-op, use of futures and options or perhaps an over-the-counter product to minimize price volatility and bring profit home, remember to keep your strategy simple. Complexity breeds confusion. Confusion will keep you on the roller coaster of price volatility. And roller coasters are fun, but you don’t have to ride one every day of your life.

David Kurzawski is a Risk Management Consultant with the Chicago office of INTL FCStone. INTL FCStone offers comprehensive risk-management and margin hedging programs and services to dairy producers, processors, traders and end-users. You can reach Kurzawski at 312-456-3611 or 

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