Don’t Panic – Prepare
Sep 06, 2013
Preparing ahead of time will help eliminate the panic-mode reaction that kicks in when the milk prices start to decline.
By Katie Krupa, Rice Dairy
This may come as no surprise, but my phone rings most often when the market takes a drastic turn lower. The producers on the other end of the line are without doubt asking, "Is it too late to hedge? Have I missed the good prices?"
My answer is always the same: No one knows what tomorrow will bring, but rather than leave it to chance, let’s create a plan that will protect your business’ profits. Preparing ahead of time will help eliminate the panic mode reaction that kicks in when the milk prices start to decline.
Risk management should be proactive, not reactive. Given the recent decline in the Class III futures prices trading on the Chicago Mercantile Exchange, below are a couple tips on being proactive in your risk management plans.
Know your financials
While it is possibly the least glamorous part of risk management, it is critical to know what a "good" price is for your business. The current hedging opportunities may be better (or worse) than you think, depending on your unique financials. Knowing your break-even price will enable you to know where you need to hedge. Hedging at break-even may provide adequate coverage to keep the business stable and your personal finances satisfied. Given the opportunity, you may be able to protect a profit that will significantly benefit your business. And for some, protecting a price below their cost is similar to catastrophic insurance against a worst-case scenario situation. Every business has different needs, so don’t be afraid to create your own unique strategy.
Place a standing order
Once you know what a "good" price is for your business, allow the market volatility to benefit you.
Many brokers and cooperatives will allow you to place an order for a hedge that is higher than the current market price. This is most commonly called a "Good ‘Til Cancelled" (GTC) order since the order will work until it is filled or cancelled. For example, if you wanted to sell a futures contract for October (fix your price) at $18.25, but the current market price is $18.00, you can place your order as a GTC order and the order will work daily until filled or cancelled. That way, if you are busy and not able to watch the markets, your order will be active and filled if the market should move high enough to get the contract filled.
Often times we will see the market quickly move higher and then lower again in a matter of minutes. If your order is not working, there is no chance of it being filled. Obviously, sometimes the price you want or need may be several dollars higher than the current market price. If this is case, it is important to be realistic on the market expectations, and review other types of strategies that may provide adequate coverage at current market prices.
Manage a margin
Knowing your financials and what milk price you need may depend heavily on the feed prices. If that is the case, I strongly recommend reviewing your milk-feed margin and hedging both your milk and your feed risks. If you are only hedging milk, or only hedging feed, you are just managing one side of the equation and not reducing your risk.
Just last week a producer asked me which I thought was more important: milk or feed hedging. I told him that a complete risk management strategy includes both milk and feed risks. The volatility exists in both the milk and feed markets, so not hedging your risks on both is leaving you vulnerable to market fluctuations.
The future outlook for the milk and feed prices are uncertain. Avoid the panic and protect your business by taking a proactive approach to your risk management plan.
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 email@example.com.Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.