costs and benefits of a very simple put-based dairy hedging strategy dr. marin bozic dairyiowa...
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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 HorizonWhat Can You Buy for 50
cents? (Option Strike)
1 month 5 cents below futures3 months 64 cents below futures5 months $1.08 below futures7 months $1.44 below futures9 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 2007-2012
Return on Investment2007-2012
1 month 16/74 -$0.14 -41%3 months 21/74 $0.06 13%5 months 19/74 $0.21 46%7 months 15/74 $0.24 52%9 months 09/74 $0.26 57%
11 months 10/74 $0.33 73%
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 [email protected] of Applied EconomicsUniversity of Minnesota-Twin Cities317c Ruttan Hall1994 Buford AvenueSt Paul, MN 55108
Acknowledgements:Fanda Yang, PhD Student UMNLou Kuhlmann, Advance Trading, Inc.