Costs and Benefits of a Very Simple
Put-based Dairy Hedging Strategy
Dr. Marin Bozic
DairyIowa
Independence, IA – June 11, 2013
Iowa All-milk Price: Jan ’07-Feb ‘13
A simple hedging program with puts
• Buy puts consistently, do not try to guess what the price will do
next
• Never spend more than 50 cents on a put
Let us evaluate three strategies:
1) Always buy puts for milk produced THREE months from now
E.g. in January 2013 hedge April milk, in February hedge
May milk, etc.
2) Always buy puts for milk produced SEVEN months from now
E.g. in January 2013 hedge August milk, in February
hedge September milk, etc.
3) Always buy puts for milk produced ELEVEN months from now
E.g. in January 2013 hedge November milk, in
February hedge December milk, etc.
A simple hedging program with puts
Hedging Horizon
1 month
3 months
5 months
7 months
9 months
11 months
What Can You Buy for 50
cents? (Option Strike)
5 cents below futures
64 cents below futures
$1.08 below futures
$1.44 below futures
$1.74 below futures
$2.08 below futures
Hedging with Puts: 3-months Out
Hedging with Puts: 7-months Out
Hedging with Puts: 11-months Out
A simple hedging program with puts
Number of
Profitable
Trades
Net
Profit/Loss
2007-2012
Return on
Investment
2007-2012
1 month
3 months
16/74
21/74
-$0.14
$0.06
-41%
13%
5 months
7 months
9 months
19/74
15/74
09/74
$0.21
$0.24
$0.26
46%
52%
57%
11 months
10/74
$0.33
73%
Hedging
Horizon
Lessons Learned?
• Either hedge consistently or not at all.
• Plan for hedging far ahead. When prices
decline, they tend to stay low for a while. If you
wait for too long, the opportunity to lock in good
prices may be gone.
• You are likely to lose money on most of your
trades. That’s OK. That does not mean that the
market is full of crooks. It means that bad times
come around infrequently, but when they do
come, you will get back plentifully.
Costs and Benefits of a Very
Simple Put-based Dairy Hedging
Strategy
June 11, 2013
Dr. Marin Bozic
[email protected]
Department of Applied Economics
University of Minnesota-Twin
Cities
317c Ruttan Hall
1994 Buford Avenue
St Paul, MN 55108
Acknowledgements:
Fanda Yang, PhD Student UMN
Lou Kuhlmann, Advance Trading,
Inc.