Dairy Futures and Options Tutorial

Use of the History of a Futures Contract for Decision-Making

The Class III, Class IV and Whey Futures contracts are cash settled to the announced Class III, Class IV and monthly NASS Whey prices.   One of the two butter futures contracts is cash settled against the monthly NASS butter prices.   The NFDM and the Delivery Butter futers contract are settled using the tradtional settlement method of futures contracts.   For the cash settle contracts it is often useful to compare the history of a particular contract with recent cash price movements.   For example, how does the current December Class III futures contract compare to the distributional characterstics of the announced December Class III prices over the last decade?

The section of the UW Dairy Marketing website devoted to the dairy products futures markets provides an easy method for examining the relationship between futures and cash prices.  For example, if you click here you will access the history of the daily settle prices of the nearby Class III futures contract from the day it started trading until the previous day's trading session.

The above graph besides showing the history of the futures contract's settle prices also displays the average of the Announced Class III price for the particular month of concern since 1995.  If one assumes that Class III prices are normally distributed, one can use the standard deviation of the Announced Class III prices to provide estimates of the Class III prices which identify where 1/3 of the distribution of Class III prices are above and below.   Anything below the lower limit could be considered an abnormally low Class III price.  Any price above the upper limit could be considered an abnormally high price.  The file Historical.BFP.xls provides a template of how to determine what are reasonable announced Class III prices.

For those time periods where the settle price is above the top 3rd of the empirical distribution this may indicate that you may want to think about hedging your output price or at least using an option to set a price floor.