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Marketing Strategies for Milk
Milk prices have had an interesting last four months. Prices moved higher starting in October and peaked with most contracts, trading between $16.50 and $18. Declining world production and increasing demand helped propel futures upward. Since early December, however, futures have leveled off.
Now is the time to take protection. Holiday demand is behind the market, and recent price improvements suggest a potential of world supplies to increase. It is anticipated that the U.S. supply could increase 2% this year. Consider forward-contracting 50% of expected 2017 production. The average of all futures contracts (February through December) as of Friday, January 27, was $17.50. With cheap feed (relative to the last 10 years) and expectations for increased production, forward-selling into a rally makes sense. Once in place, your downside risk is fixed, yet your ability to gain in a rally is also fixed. If this is a concern, consider buying call options. Which strike price may be open for debate? We suggest buying calls that are out of the money by 50¢ or more. Strike prices are every 25¢. A call provides you the right to own futures (not the obligation). If prices resume their uptrend, call options can allow you to participate in a price rally. The simple goal here is to establish a risk-shifting positon (forward selling) while positioned for upside potential.
There are some who may argue that calls are unnecessary. Yet, if prices move higher, they provide upside price appreciation potential and can act as a catalyst for you to sell more milk. In our experience, it is not unusual for producers to reward rallies with sales. If prices move higher, they may feel they made a mistake and hold off rewarding higher prices. With calls in place, the idea of selling too soon is, in part, negated.
On the remaining 50%, consider purchasing put options. Puts provide the buyer the right (not the obligation) to sell futures (hedge). Puts are a mechanism to establish a price floor. Yet, price appreciation for your actual production is left wide open.
The strategies above are designed to protect 100% of expected production should prices move lower. If prices move higher, 50% is unpriced. And if you purchased calls, another 50% can participate in a price rally.
There is a cost to marketing, so compare this to the cost of doing nothing. Doing nothing is likely the most speculative position. You are open to the highs and also the lows. Yet, how often do you take advantage of the highs? Typically, when supplies become burdensome, it takes longer for a market to recover from low prices, as it likely requires a combination of growing demand and decreasing supplies to establish a price turnaround. Neither of these has a tendency to occur quickly, at least not in most cases. Consider how a well thought-out, risk-adverse strategy can help you manage risk and provide the confidence to capture opportunities when they are presented.
If you have questions or comments, or you would like help in creating a balanced strategy for your operation, contact Bryan at Top Farmer Intelligence (800/TOP-FARM, Ext. 129).
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.