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 Februaryhedge 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 What Can You Buy for 50 cents? (Option Strike) 1 month 5 cents below futures 3 months 64 cents below futures 5 months $1.08 below futures 7 months $1.44 below futures 9 months $1.74 below futures 11 months $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 Hedging Horizon Number of Profitable Trades Net Profit/Loss Return on Investment month 16/74-$ % 3 months 21/74$0.0613% 5 months 19/74$0.2146% 7 months 15/74$0.2452% 9 months 09/74$0.2657% 11 months 10/74$0.3373%

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 Department of Applied Economics University of Minnesota-Twin Cities 317c Ruttan Hall 1994 Buford Avenue St Paul, MN Acknowledgements: Fanda Yang, PhD Student UMN Lou Kuhlmann, Advance Trading, Inc.