The CME “Milk” contract replaced the “BFP Milk” contract in January 2000, to properly reflect the price of milk used in the manufacturing of cheese under the revised government federal p
Trang 1Why does the CME now offer
two Milk contracts?
The Milk (Class III) was changed from
the BFP in January 2000 to conform to
the new component pricing structure of
the dairy "reform" legislation for milk
used in the manufacturing of hard
cheeses It has provided an excellent
risk management tool for the
cheese-milk industry.
The CME added the Class IV Contract
in July 2000 in response to industry
comments dealing with the hedging of
butterfat risks using the revised Milk
(Class III) contract The "reform"
legislation changed the price
relationships of Class III cheese-milk
with the other classes, making the CME
Milk contract not as closely correlated
as was the old BFP.
Also, since the component formulas for
Class II Milk are similar to the Class IV,
the addition of the Class IV provides a
direct hedge for ice cream, yogurt and
other perishable manufactured
products, along with firms whose
processing accumulates butterfat
inventory.
And as an added benefit, the Class I
(fluid milk product) users will have the
option of using either the existing Milk
(Class III) or the new Class IV,
depending on their outlook for cheese
and butter price relationships.
Producers hedging on their own in areas
with a high Class I & II utilization, and
their cooperatives who offer them
forward contracts, will have a more
reliable hedge with the Class IV.
Cooperatives may also combine the
existing Milk contract with Class IV
contracts to "fine tune" their forward
contracts to their producers In addition,
the combination of the current Milk and the new Class IV will expand hedging opportunities to the entire California dairy industry.
Traders will also be able to spread the Class III against the IV depending on their outlook for butter and cheese.
Trang 2How does the Milk Class III price relate to the historical price
information of the BFP?
The CME “Milk” contract replaced the “BFP Milk” contract in January 2000, to properly reflect the price of milk used in the manufacturing of cheese under the revised government federal pricing classification system for all uses of milk The CME Milk contract is cash settled (monthly) to the Class III National Agricultural Statistics Service (NASS) announced price, released no later than the fifth day of
following month All other aspects of trading the contract remain the same.
1 Consult your broker for additional information or specific requirements, policies and procedures.
2 Trading times may vary; consult the CME for holiday schedule.
Class III Monthly Averages and Ranges, 1995 to 2000
8.50
10.30
12.10
13.90
15.70
17.50
Hi 16.27 13.32 12.81 13.09 13.77 13.92 14.77 15.79 16.26 16.04 16.84 17.34
Lo 10.05 9.54 9.54 9.41 9.37 9.46 10.66 10.13 10.76 10.02 8.57 9.37 Avg 12.60 11.66 11.84 11.49 11.18 11.68 12.60 13.25 13.73 12.85 12.11 12.31 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Trang 3Why have milk prices become so volatile?
The lowering of price supports by the government, along with increased demand, mainly for cheese and cheese products, have brought about a price equilibrium between the supply of milk and the uses of milk Thus, any seasonal changes in the production or demand for milk and milk products create volatile price swings.
Milk P roduction v s C omm ercial C onsum ption
105
119
133
147
161
175
Produc tion 115 120 123 121 123 128 133 136 140 135 143 143 143 144 148 148 151 151 154 155 154 156 157 163 168
Commerc ial Us e 114 116 116 119 120 119 120 122 122 127 130 133 136 135 139 139 141 145 150 155 155 157 160 165 169
75 76 77 78 79 80 81 82 83 84 85 86 87 89 90 91 92 93 94 95 96 97 98 99 00
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Milk & cream Butter Amer cheese Non-American Total cheese Cottage Ice cream Lowfat ice NFDM Whey
Per-capita consumption, 1980 vs 1999
1980 1999
Trang 4How does the new Class IV relate to the CME Milk Class III
contract?
The simplest answer is to define the pricing structure of the two classes of milk The Class III is milk used in hard cheeses and the Class IV is milk used for butter and dried milk products A more complex answer would define the method derived by the USDA’s NASS Agency in calculating the pricing formulas for the two classes of milk (See both USDA NASS release dates and formulas at the back of Primer) Of significance (to both hedgers and traders) is the price relationship of the major milk component of cheese (protein) which constitutes Class III pricing and butter (butterfat), which constitutes Class IV pricing.
Class III vs Class IV
10.50
11.20
11.90
12.60
13.30
14.00
Class III Class IV
Trang 5How is the Class III Milk price established?
NASS conducts weekly industry-wide surveys on cheese, whey, and butter cash transactions These prices are volume-weighted and incorporated into a pricing formula to determine the monthly Class III price for milk with 3.5% butterfat On Friday of each week, the USDA reports the changes in the average prices from the prior week Both traders and hedgers can monitor this information to gain insight as
to the final cash settled price.
How is the Class IV Milk price established?
NASS uses weekly industry-wide surveys on butter, whey, and nonfat dry milk cash transactions These prices are volume-weighted and incorporated into a pricing formula to determine the monthly Class IV price for milk with 3.5% butterfat On Friday of each week, the USDA reports the changes in the average prices from the prior week Both traders and hedgers can monitor this information to gain insight as
to the final cash settled price.
What are the classifications of Milk?
Class I
Milk used to produce fluid milk products, such as bottled milk.
Class II
Milk used to produce soft manufactured dairy products such as cottage
cheese, ice cream and yogurt.
Class III
Milk used to produce cream cheese and hard manufactured cheese This is the type of milk reflected in the CME milk contract.
Class IV
Milk used to produce butter and all dried milk products This is the type of milk reflected in the CME Class IV contract.
Trang 6How to Trade CME Milk Futures Contracts –
(Reference Class III or Class IV Futures Contract Specifications)
The following examples and illustrations of “How to Trade Futures Contracts”, “How
to Trade Milk Options”, “Hedging CME Milk Futures” and “Hedging with CME Milk Options” relate to both the CME’s Milk (Class III) contract and the new Class IV Likewise, the principles are the same for Buy/Sell hedgers pricing Class I milk, using either of the two contracts.
Benefits
The CME Milk futures and options contracts offer easy entry into futures and options markets The Milk futures and options contracts trade each month, can be offset at any time, or can be held through contract expiration and be automatically offset at the USDA’s announced price for Class III and IV Milk.
What is a Futures Contract?
A futures contract is a legally binding obligation to buy or sell a commodity that meets set grades and standards on some future date.
Type of Positions Price Advantage In: To Offset Position1
Sell = Short Down Markets Buy Back Contract
(Loses in up markets)
(Loses in down markets) Futures Example: Buy low/sell high, or vice versa
As a speculator, if you think prices are going higher, then you would buy Milk futures If you think prices are moving lower, then you would sell Milk futures To close out or offset your trade, take the opposite position.
1 All futures contracts require a fulfillment, or binding obligation, on the part of the trader at some time before the contract expires Traders of the Milk contract may fulfill contract obligations by offsetting in the futures market (entering an opposite trade order) any time prior to contract expiration, or by accepting an automatic offset at the Class III announced price on the date of the announcement.
Trang 7Although it's risky, it's that easy Let's look at an example What happens if it's April and July CME Milk futures are at $12.00 per hundredweight, and you either buy or sell!
In April, trade July futures at $12/cwt
If prices move by $1/cwt., a speculator may experience either a $2000 ($1 x 2000/cwt.) per contract profit or loss Note: Brokerage commission is not included in example
A hedger uses futures in a different way While speculators take the risk, a hedger locks in
a known price for milk The profit or loss on the futures position would virtually counteract gains or losses in the cash position (See How to Trade CME Milk Futures and Options)
Trading Example
Each open Milk futures contract must be backed by a performance bond (margin) account
As prices move, money will be transferred into or out of your account during each trading session You may be asked to post more performance bond funds, if prices move too far against your position Of course, if prices move in a positive way for you, your account is credited accordingly The following example is based on $1,000 performance bond requirements and a maintenance margin of $800 for each Milk contract (Margins are subject to change so check with your broker.)
A trader opens an account and deposits $1,000 initial margin; his account balance is
$1,000 If he buys (goes long) a June Milk contract at $12.00, and the price closes up one cent at $12.01, his account balance increases to $1,020 If the Milk market closed down one cent at $11.99 at the end of the day, his account balance decreases to $980 Similarly,
a trader selling (going short) a June Milk contract at $12.00 would see a decrease of $20 in his account balance if the contract closed up one cent and an increase of $20 if the Milk contract month closed down one cent
Margining a Futures Trade
Along with the performance bond requirements, the exchange also sets a minimum maintenance margin for each commodity This level is set as a “trigger” point for margin calls In the above example (initial margin $1,000 and the maintenance $800), the trader’s account balance would have to drop $220 ($1,000 - $220 = $780) or (11 cents x $20) to have an account balance below $800 and be subject to a margin call The trader would be obligated to meet the call to re-establish the account balance to 1,000, or be subject to automatic removal from the market
Commodity Brokers
All Milk trades you make must be placed through a registered commodity broker Brokers charge a commission on each transaction They can advise you which market orders to use and help provide both fundamental and technical information on market price outlook To locate a broker, you might ask around, or give us a call
Trang 8How to Trade Milk Class III or Class IV Options
Options Benefits
Options on agricultural futures are relatively new, beginning back in October 1984 They
offer many advantages For buyers of options on CME Milk (Class) futures, these include:
• Limited losses
• Unlimited profits
• No performance bonds (margins)
An option is the right, but not the obligation, to buy or sell a futures contract at a specific price The cost of an option is the premium, which is paid up front Speculators buying
options can only lose the premium paid, if wrong; but can profit substantially if right Hedgers buying options also have limited loss, but unlimited gain potential Thus, hedgers
can use options to protect their cash position from adverse price moves, while retaining most of the gain in cash value from favorable price moves
The buyer of a Milk option has four choices:
• Offset the option
(sell back the same option (put or call) and receive the gain in value)
• Simply let the option cash settle at expiration and collect gains in value
• Exercise the option
(take the futures position)
• Let the option expire
Options on Futures
Because Milk options are based on Milk futures, their technical specifications are almost identical Options on milk futures are listed in the same trading months as futures contracts
New Terms
Trading options is just as easy as trading futures with a lot of flexibility There are two kinds
of options:
• Put: The right to sell a futures contract
• Call: The right to buy a futures contract
Puts increase in value if prices fall, and decrease in value if prices rise Puts give the
buyer (holder) the right to exercise into a sell (short) futures position at a fixed price.
Calls increase in value if prices rise, and decrease in value if prices fall Calls give the
buyer (holder) the right to exercise into a buy (long) futures position at a fixed price.
Trang 9The strike price (exercise price) is the fixed price at which the holder of an option has the
right to take a futures position As noted, buyers of fluid milk puts or calls may choose from many strike prices at 25-cent intervals For example, if futures are at $12, there would be strikes both above and below $12, such as $12.50, $12.25, $12.00, $11.75, $11.50, etc
The premium (quoted in $/cwt.) is the cost of a milk option Thus a $.50 premium would
cost $1,000 ($.50 x 2000 cwt.) per contract Buyers of options can only lose the premium paid The premium value will change every time the underlying futures price changes
Put Example
Say it's April and July Milk futures are at $12/cwt What happens if you buy a July $12 put
for $.50/cwt.? Answer: In July, the $12 put will have value if futures prices fall below
$12.00: if prices go above $12.00, however, they will expire worthless
In April, July futures = $12/cwt Buy July $12 put at $.50/cwt.
PREMIUM
A speculator selling back a $12 put would have a $3000 ($2.00 x 2000 cwt – $.50 x
2,000 cwt premium cost) per contract profit if futures prices fell $2 There would be a
$1000 ($.50 x 2000 cwt.) per contract cost if prices stayed the same or rose $2 (commission not included)
A hedger uses put options in a different way If prices fall, the option profit protects a
minimum selling price or acts as an insurance policy for milk If prices rise, the option
loss (cost of premium) is offset by the better cash selling position
Call Example
In the same situation as before, a July $12 Milk call may be worth $.50/cwt in April What would happen if you bought it? Answer: In July the $12 call will have value if prices stay
above $12, or expire worthless if the futures price falls below $12.
In April, July futures = $12/cwt Buy July $12 put at $.50/cwt.
PREMIUM
A speculator selling back a $12 call would have a $3000 per contract profit if futures
prices rose $2 There would be a $1000 per contract loss if prices stayed the same or fell
$2 (commission not included)
A hedger uses call options in a different way If prices rise, the option profit protects a
maximum purchase price for milk If prices fall, the option loss (cost of premium) is offset
by the better cash buying position
Trang 10Hedging with CME Milk Class III or Class IV Futures
Hedging with Milk Futures
The CME Milk Futures contract offers easy entry into futures and option markets Futures and option contract months will be listed for each month of the year, providing both producers and users a chance to lessen the pricing impact of the monthly USDA’s Class III announcement Producers concerned about their milk checks declining in the future can sell milk futures; while users of milk and milk products can protect against rises in the milk price by buying futures It is as simple
as that!
How to Hedge with Milk Futures
All futures contracts are traded the same way Both hedgers and traders need to establish a futures/options account with a commodities brokerage firm and comply with the firm's contract performance bond requirements Your broker will assist you
in the order entry procedures and any questions you may have on the milk contract specifications.
Note: Even though the correlation between Class III price changes and your cash prices are close enough to offer price protection, it is unlikely that hedging will (exactly) offset cash price fluctuations Knowing the relationship of how your price moves with the Class III price (basis) will help make your hedging transactions even more meaningful.
Definition of Hedging
Taking a position in futures that fully or partially offsets price risk from your present cash position.
Owner of Inventory
§ Risk in Down Markets
Seller of Contracts (Short)
§ Gain in Down Markets
User of (Needs) Inventory
§ Risk in Up Markets
Buyer of Contracts (Long)
§ Gain in Up Markets