Futures Application

Basis
Hedging in Futures
Buy a Put
Cash Forward Contract
Sell a Call
Cash Contract & Buy a Call
Short Fence
Roll Up Futures
Roll Down Futures
Roll Up Put

Basis Calculation

Select Area:

Select Year:

Enter Custom Mailbox Prices: (all costs are reported in $/cwt)

Basis is calculated by subtracting the Announced Class III milk price from your mailbox price. Basis includes any premiums for protein, butterfat, quality, volume, and the producer price differential (PPD).
*Values in green are expected class III prices.
*Values in blue are predicted Mailbox prices.

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Hedging in Futures

Description

Use short hedge to lock in your unknown output price
By entering the futures contract sell price and basis you can effectively lock in this price for your cash product.
With a short hedge you sell a futures contract which commits you to sell in the future at the specified price
You are now long in the cash market (own the product now) and short in the futures market
Unless you lift your hedge, any gain or loss in the cash market relative to the current price will hopefully be offset by a loss or gain in the futures markets
At the end of the contract when you sell your milk in the cash market you will cash settle (e.g., buy back) the futures contract at the announced Class III settle price
Hedging in Futures Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Buying a Put Option

Description

Use when you want to establish a minimum price for your output while leaving the opportunity for you to benefit from future price increases
May consider this as a strategy anytime recognizing it is a conservative strategy
Consider it when commodities futures are trading at prices that are not attractive to your price/cost objective, but don't want the situation to deteriorate any further
A better outcome than hedging when output prices actually increase
Buying a Put Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Cash Forward Contract

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Sell a Call

Description

Consider when there has been a sideways movement in output price (output price neither increasing or decreasing) and options premiums are relatively high (can collect a good premium when sell an option)
Establishes a ceiling for your output price at a higher level than if had hedged when prices increased
Requires caution as there is no floor to how low your output price could go if prices actually decrease
Sell a Call Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Cash Contract and Buy a Call Option

Description

Consider after price outlook for your product turns from bearish to bullish (expect prices to increase)

Farm operator establishes a "base price" through forward milk price contract system

When the contract was entered into, the price outlook was bearish (expected prices to decline)
Currently, outlook is for much stronger prices

Producer buys a CALL option to establish a floor price lower than the original contract price by CALL option premium

If the milk prices increase, a gain will be realized by exercising the CALL option

Net mailbox price (if a Class III contract) will be higher than original contract price

If prices decrease, the net mailbox price will be lower by the amount of the premium

Cash Contract and Now Buy a Call Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Short Fence

Description

Consider this when market opinion is slightly bullish (prices may increase) and premiums for options are relatively high
Usually buys an out-of-the-money PUT option first and sells an out-of-the-money CALL
Establishes both a price ceiling and floor (hence the name short fence)
If output price increases, net price comes out better than if had hedged
If prices decrease, net price is lower than if had hedged
Short Fence Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Buying a Put Option, Roll Up to Futures

Description

A good strategy to consider following a period of ever increasing output prices but now there is a good probability that prices will decline
Producer establishes a output price floor by purchasing a PUT option
Futures market outlook turned bearish (feeling that prices will decline)
Producer will undertake a short hedge (sell futures) to establish a higher price floor
If cash price does indeed drop, net price will come out better than the original PUT option
- Possible gain from both the PUT and hedge
If cash price increases, the established new higher floor price is also a price ceiling
- Loss from the hedge offsets gains from rising prices
Roll Up to Futures Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

Use when producer has already established a price floor with a put option. But there has been a rally with Class III futures but it looks like there will be a downturn in the near future.
* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Roll Down Futures to a Put

Description

Strategy may be considered when producer has originally undertaken a short hedge
- Output price have since gone down
- Producer is of the opinion that prices have bottomed and are about to rise
The producer gets out of the hedge by offsetting (buying a futures)
Buys a PUT option to establish a floor price in case the above forecast is wrong and output price declines further
If output prices increase, the new price will be higher than the original hedge
If output price decreases, net output price will be lower
Roll Down Futures to Put Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.

Roll Up to a Put

Description

Strategy should be considered after a rally in product's futures price
Price outlook is for continued price increases
You still are cautious
Producer first purchases a PUT option to establish an initial floor price
Strategy allows producer to buy another PUT option at a higher strike price to establish a higher floor price
Original PUT option can be sold to re-capture part of premium paid
If prices do increase, the net price will be lower than the original PUT strategy
- The first premium will not be able to be recovered
If prices decrease, net price will be higher because of the higher floor
Roll Up to a Put Example

Data Input (all costs are reported in $/cwt)

Results from strategy under Alternative Class III Announced Prices

* Mailbox Price is equal to announced price plus basis.
** Announced price is equal to Class III price.