By: Dan Hofstad
Dairy commodity markets have traditionally been hindered by low liquidity and volatile futures prices. And typically, dairy products comprise a sizable portion of cost-of-goods-sold for many consumer-packaged goods (CPG) companies and food manufacturers. This presents a challenge for those in charge of managing their company’s price risk management programs.
For producers and consumers of products like butter, cheese and milk, the entrance of OTC market-makers and participants has been a welcome sight. Hedgers who are looking to manage very large volumes of physical dairy product risk need to find other solutions.
OTCs and exchange-based futures and options have been trading side-by-side in many markets for decades. There is an apparent growth trend of OTC hedging strategies over the last three years.
The advantage of an off-exchange traded hedging strategy, negotiated between two OTC market participants, creates an opportunity for both buyer and seller to offset one another’s risk in one transaction; better meeting both of their needs. This activity provides additional and effective avenues for dairy industry participants to hedge the products they buy and sell every day and better manage price risk.
As the dairy OTC market has matured, it has also evolved with offerings in customized hedging solutions. With these strategies, a hedger can specify size, tenor of the hedge and ultimately the risk-reward profile versus the underlying market. In doing so, those seeking to manage dairy price risk have an array of tools at their disposal in addition to exchange-based products.