Why Have Dairy-Based Futures Contracts Become an Important Part of Dairy Marketing?
- Change in federal dairy policy:
- From 1950 to 1981, dairy price support system based on parity
- This provided price stability and a market outlet
- Since 1981, dairy price support levels determined by Congress
- Current Federal dairy policy is market oriented which results in
- increase market risk
- increased price risk
Why some industry participants say we don't need dairy-based futures and options.
- We market milk every day and get paid once or twice a month. One comes out okay because of averaging.
What is the purpose of futures markets?
- Reduce the risk of price change: Increase the level of price certainty
- Hedging: Simultaneous but opposite transactions on the cash and futures markets
- Hedging theory:
- Cash Market Losses (Gains) = Futures Markets Gains (Losses)
- Fixed Price Contracts: Allow for users of farm-milk to offer fixed price contracts
Why are industry participants increasing in their use of dairy-based futures markets to manage their price risk?
The opportunity to lock in a price is worth more than the opportunity to make more if the price goes up. That is, reaching a desired price (profit) objective is more important than reaching a high but very unlikely price level.
The price for cheese and milk will go up and down, but if one is hedged or has a cash forward contract, price will be known.