Milk futures have been trading on the Chicago Mercantile Exchange (CME) since 1996 in one form or another. CME has refined its futures contracts over time to keep up with the ever-changing government price support program for milk.
Cash settlement was originally based on the Minnesota-Wisconsin (MW) price, then the Basic Formula Price (BFP), and currently the Class III milk price. Class III milk is also known by the industry as “cheese milk,” the milk used to produce American cheese. Class IV milk futures began trading in 2000. Class IV milk is used to produce butter and non-fat dry milk.
All of CME’s dairy futures products, except butter, are cash-settled to the National Agricultural Statistics Service (NASS) monthly price. Class prices are based on formulas calculated by United States Department of Agriculture (USDA). Monthly government numbers used to settle the Class III and IV milk futures are released on the Friday before the 5th of the following month. If the 5th falls on Friday, data is then published on that Friday. Monthly data can be found on the USDA website.
CME Milk Futures Specifications
Class III CME Milk futures trade under the symbol DA. The contract size is 200,000 lbs of Grade A cow’s milk. The contract trades in ticks of $.01 per cwt., worth $20 per contract.
The trading hours are Sunday through Thursday, 6:00 PM US EST until 5:00 PM US EST the following day, closing on Friday at 2:55 PM US EST.
Milk Futures Example
To illustrate a hedge on an upcoming milk sale, let’s assume it’s July 1 and the milk producer is planning for December milk production. Feed and hay prices for the production year are locked in with forward contracts.
The manager wants the assurance that the milk revenues will cover expected cash costs during December. The producer just returned from a co-op outlook meeting where the December BFP was predicted to be $11.04. Since the producer’s December basis averages +$1.96, he realizes he faces a possible $13.00 milk check for December milk if that prediction comes true.
Next, the producer finds that the BFP December futures contract closed for the day at $12.54. The producer needs a $13.89 per hundred weight milk price to cover costs in December.
Using futures, the producer decides he can hedge 1,400,000 pounds of his expected December production of 1,490,000 pounds. BFP contracts and options are offered in 100,000 pound and 200,000 units. A 50,000 mini option is also offered.
By leaving 90,000 pounds un-hedged, the producer feels he is allowing for possible production variation. An at-the-money put option will cost $.35 per hundred weight. However, the option will allow him to escape margin calls and have the potential to gain back some premium if he chooses to sell the option rather than let it expire.
Using options, the producer can lock in a milk price of $14.11 for the hedged portion of his milk by purchasing puts with a strike price of $12.50. The producer realizes that hedging with futures contracts has the potential to net more money if the milk price falls.
You might never have thought about trading milk futures before, when most people think of futures they think of indices or individual stocks. But milk futures can be a very lucrative addition to your portfolio.
Why? Well any self respecting investor needs a balanced portfolio; you can’t expect to make significant long term gains if your entire portfolio is dependent on gold prospectors in North Africa.
So it’s a good idea to spread the risk over a number of commodities, even better if you can find a commodity that we can’t live without. Oil is a prime example of this, but so is Milk.
The advantage milk futures have over oil futures is that they’re much more stable, partially because the milk market is “ahem” less liquid (pardon the pun). This is due to the fact there’s much less speculation within milk futures, but also because supplies are generally more stable. As far as I’m aware, a war has yet to be fought over a field full of cows.
So how do you get in on the action? Well you need to find a broker that offers milk and dairy futures. Don’t just choose the first one you come across, the training and support your broker provides is vital to your success.
For this reason we always recommend new traders, open an account with optionsXpress. They might not be the cheapest broker, but they more than make up for this by offering some excellent training tutorials. Add to this superb customer support and a virtual trading account and you’re all set.