A Dairy strip is the purchase or sale of a series of Dairy futures contracts, representing up to 18 consecutive months along the forward curve, as a single transaction. The price of the strip will be the average of the leg price.
Because Dairy strips are transacted at a single price, they eliminate the necessity of entering multiple orders in each individual contract, and risking the possibility that some of the legs may go unfilled due to movement in the market before all legs are completed.
A Dairy strip facilitates planning operations and cash flows for producers and manufacturers by allowing them to lock in a fixed price over a defined period.
Spreading, a trade in which you simultaneously buy one futures contract and sell another, is a commonly used trading strategy in the dairy markets. One reason is that spread strategies typically involve less risk than outright futures positions, and as a result, also tend to have lower margin requirements.
First, an intramarket calendar spread is the combination of a long futures position and a short futures positions in the same dairy product, but different contract months. One example would be the November - December Class 3 Milk Spread.
Calendar spreads focus on changes in the relationship between the two contract months; the goal of this strategy is to take advantage of those changes. In most cases, there will be a loss in one leg of the spread, but a profit in the other leg. If the spread is successful, the gain in the profitable leg will outweigh the loss in the losing leg.
Calendar spreads also are used by hedgers to roll a Dairy futures position from one delivery month to the next.
An Intermarket spread is simultaneously buying and selling two different but related Dairy futures with the same contract month, in order to trade on the relationship between the two commodities.
For example, the Class 3 -Class 4 Milk spread is an instrument for trading on the relationship between Class 3 Milk and Class 4 Milk futures prices. The price relationship reflects a difference in the supply and demand fundamentals of the underlying products: Cheese and Whey for Class 3 Milk, and Butter and Nonfat Dry Milk for Class 4 Milk.
Commodity product spreads involve buying and selling futures contracts based on a raw commodity, versus futures based on the derived or processed commodities—such as the Class 3 Milk Crush, which entails buying Class 3 Milk futures and simultaneously selling Cheese, Whey and Butter futures.
The Class 3 Milk Crush spread allows dairy processors to hedge their price risks, while traders will look at the spread to capitalize on potential profit opportunities.
As previously mentioned, one of the attractions of spread trading is the relatively lower risk vs outright futures positions, and the subsequent lower margins. Let’s see how this works with the Class 3 Milk-Cheese spread.
Let’s say that In October, the outright margin for Class 3 Milk futures was $1,000 and the outright margin for Cheese futures was $1,100.
Rather than posting $2,100 to trade both futures contracts, the Class 3 Milk-Cheese spread traders actually receive a 55% margin credit—in other words, the initial margin was $945 to reflect the lower risk in spreading the two contracts, as opposed to trading each of them outright.
There are many dairy strategies that allow hedgers to manage risk and traders to capitalize on potential opportunities. No matter what their goals and objectives are, CME Group Dairy futures and options offer a variety of flexible choices to meet their needs.