If you have been monitoring milk prices on the futures market, you are likely aware that they are quite high. For example, the contracts for Class III milk for September, October, and November have recently been trading around the $22 per hundredweight (cwt.) mark. Given that such high prices are uncommon, farmers may have an opportunity to manage risk by locking in or hedging milk prices. Below are some principles to help you understand how to lock prices in the futures market.
Locking a price means that the farmer chooses a price at which they would like to sell their milk, ensuring that the final selling price matches the one they selected. For example, suppose a farmer sells a futures contract of Class III milk for November 2024 at $21.79 per cwt. If USDA announces on December 4, 2024, a Class III milk price of $18.73 per cwt. due to a hypothetical market downtrend, the farmer would gain $3.06 per cwt., or $6,120 per traded contract. While the farmer gains in the futures market, they would also receive less money from the milk check due to the lower market price.
On the other hand, if USDA announces on December 4, 2024, a Class III milk price of $23.02 per cwt. due to a hypothetical market uptrend, the farmer would incur a loss of $1.23 per cwt., or $2,460 per traded contract in the futures market. However, they would receive more money from the milk check thanks to the higher market price.
Finally, if USDA announces on December 4, 2024, a Class III milk price equal to $21.78 per cwt., indicating market stability, the farmer would neither gain nor lose substantially, earning only $0.01 per cwt., or $20 per traded contract in the futures market. In this case, the milk check would remain unaffected.
These examples illustrate the basics of how price locking in the futures market works. It is strongly recommended that farmers consult a broker before implementing this strategy. Typically, brokers charge a fee for each transaction. For example, if a broker charges $70 per transaction, and each contract requires two transactions (one to buy and one to sell), the brokerage fee would total $140 per contract. Since the contract is for 2,000 cwt., the resulting brokerage fee is $0.07 per cwt., which is relatively modest.
The current market conditions may be favorable for locking in milk prices. If you are interested in locking prices, consider contacting a broker for guidance. If you are not yet ready but want to learn more about locking milk prices in the futures market, you can access a free e-learning program called “Managing Milk Prices Using the Futures Market” developed at Virginia Tech. To access the program, request login information by emailing dairymanagementvt@gmail.com. Once you receive the login details, visit https://dairymanagement.cals.vt.edu and access the module. Who knows — after completing the program, you might feel more comfortable reaching out to a broker.
