Comparison of MPP-Dairy and Other Margin Risk Management Systems
Use of
Use of
MPP-Dairy
MPP-Dairy
vs. Other
vs. Other
Margin Risk Management
Margin Risk Management
Systems: How Do They
Systems: How Do They
Compare?
Compare?
Prof. Brian W. Gould
Prof. Brian W. Gould
Department of Agricultural and Applied Economics
Department of Agricultural and Applied Economics
University of Wisconsin-Madison
University of Wisconsin-Madison
University of Wisconsin Extension
University of Wisconsin Extension
PowerPoint Presentation:
PowerPoint Presentation:
The National Program on Dairy Markets and Policy
1
www.dairymarkets.og/MPP/PowerPoint/Option_LGM_MPP.pptx
www.dairymarkets.og/MPP/PowerPoint/Option_LGM_MPP.pptx
MPP-Dairy
MPP-Dairy
and Use of Other
and Use of Other
Margin Risk Management Systems
Margin Risk Management Systems
•
MPP-Dairy
enrollment: No impact on
enrollment: No impact on
ability to use other risk management
ability to use other risk management
systems except for
systems except for
Livestock Gross
Livestock Gross
Margin for Dairy (
Margin for Dairy (
LGM
)
)
–
Cannot participate in both programs
Cannot participate in both programs
–
Use of
Use of
LGM
LGM
impacts procedures to enroll
impacts procedures to enroll
in
in
MPP-Dairy
MPP-Dairy
if desired
if desired
–
Does impact complementary use of other
Does impact complementary use of other
systems
systems
October 3, 2024
2
The National Program on Dairy Markets and Policy
MPP-Dairy
MPP-Dairy
and Use of Other
and Use of Other
Margin Risk Management Systems
Margin Risk Management Systems
•
Can still
Can still
–
Forward contract farm milk with processor (except
Forward contract farm milk with processor (except
Class I) and purchased feed from supplier
Class I) and purchased feed from supplier
–
Continue to use futures and/or options if desired
Continue to use futures and/or options if desired
•
If use
If use
MPP-Dairy
MPP-Dairy
may want to protect
may want to protect
–
Additional milk component values
Additional milk component values
:
:
MPP-Dairy
MPP-Dairy
assumption that milk has average quality and price
assumption that milk has average quality and price
–
Uninsured milk
Uninsured milk
:
:
Slow
Slow
APH
APH
growth starting after enrollment
growth starting after enrollment
90% maximum program coverage
90% maximum program coverage
October 3, 2024
3
The National Program on Dairy Markets and Policy
Margin Risk Management:
Options Based
•
Before we talk about
Before we talk about
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
lets quickly review a simple options based
lets quickly review a simple options based
strategy for establishing an IOFC
strategy for establishing an IOFC
floor
floor
–
Class III put: Establishes
Class III put: Establishes
minimum
minimum
milk value
milk value
–
Feed-based equivalent call: Establishes
Feed-based equivalent call: Establishes
maximum
maximum
feed cost ($/cwt milk)
feed cost ($/cwt milk)
Corn
Corn
SBM
SBM
October 3, 2024
4
i.e., Convert feed to corn
i.e., Convert feed to corn
and SBM equivalents
and SBM equivalents
The National Program on Dairy Markets and Policy
Margin Risk Management:
Options Based
October 3, 2024
5
$/cwt
Milk revenue floor
Feed cost ceiling
Min.
Min.
IOFC
IOFC
Market Price/Cost
($/cwt milk)
IOFC
IOFC
*
*
IOFC
IOFC
**
**
$P*
$P
$P
*
*
Class III
Class III
Put
Put
Strike Price
Strike Price
→
→
$C
$C
*
*
Feed
Feed
Call
Call
Strike Price
Strike Price
→
→
$C*
IOFC
IOFC
**
**
> IOFC < IOFC*
> IOFC < IOFC*
The National Program on Dairy Markets and Policy
Margin Risk Management:
Options Based
•
Problems with this strategy
‒
Could by expensive especially in volatile markets
‒
For small operations, contract sizes may be
problematic
200,000 & 100,000 lb –
Class III
(options)
‒ 110/55 cow herds assuming 22,000 lbs/cow
5,000 bu –
Corn
&
Soybeans
100 tons –
Soybean Meal
‒
May not be able to undertake desired strategy due
to relatively thin Class III options market
Someone must be willing to sell the put option
October 3, 2024
6
The National Program on Dairy Markets and Policy
Margin Risk Management:
Margin Risk Management:
LGM
LGM
•
MPP-Dairy
MPP-Dairy
sign-up:
sign-up:
‒
Can sign-up anytime over life of Farm Bill
Can sign-up anytime over life of Farm Bill
during designated sign-up periods
during designated sign-up periods
‒
After sign-up, enrolled until end of 2018
After sign-up, enrolled until end of 2018
•
Before initial sign-up producers may want to
Before initial sign-up producers may want to
evaluate merits of
evaluate merits of
MPP-Dairy
MPP-Dairy
vs.
vs.
LGM
LGM
•
Lets quickly review
Lets quickly review
LGM
LGM
and then compare
and then compare
each programs’ characteristics
each programs’ characteristics
October 3, 2024
7
The National Program on Dairy Markets and Policy
LGM
LGM
: An Overview
: An Overview
•
LGM
LGM
used to manage IOFC volatility
used to manage IOFC volatility
–
Establishes
Establishes
minimum
minimum
IOFC similar to above
IOFC similar to above
put/call options strategy
put/call options strategy
No
No
options actually purchased
options actually purchased
–
Markets only used as information source
Markets only used as information source
No
No
minimum size limit unlike options contracts
minimum size limit unlike options contracts
Coverage Upper limit
Coverage Upper limit
: 240,000 cwt over 10 mo. or
: 240,000 cwt over 10 mo. or
within a single insurance year
within a single insurance year
Premium not due until
Premium not due until
after
after
11-month insurance period
11-month insurance period
regardless
regardless
of number of insured months
of number of insured months
Known subsidized producer premiums and direct
Known subsidized producer premiums and direct
payments to insurance providers
payments to insurance providers
October 3, 2024
8
The National Program on Dairy Markets and Policy
LGM
LGM
: An Overview
: An Overview
•
LGM
LGM
is customizable with respect to:
is customizable with respect to:
–
Number of months insured by a contract: 1 – 10
Number of months insured by a contract: 1 – 10
–
% of monthly marketings insured: 0 – 100%
% of monthly marketings insured: 0 – 100%
% insured can vary across month
% insured can vary across month
–
Deductible chosen: $0 −$2.00/cwt
Deductible chosen: $0 −$2.00/cwt
Amt. margin falls below target before indemnity created
Amt. margin falls below target before indemnity created
–
Direct producer premium subsidy: 18% – 50%
Direct producer premium subsidy: 18% – 50%
Subsidy increases with higher deductible
Subsidy increases with higher deductible
–
Program declared ration
Program declared ration
•
Given the above →
Given the above →
farm specific
farm specific
premiums
premiums
October 3, 2024
9
The National Program on Dairy Markets and Policy
LGM
LGM
: An Overview
: An Overview
•
If insured margin greater than actual margin
If insured margin greater than actual margin
for
for
entire contract
entire contract
→
→
indemnity
indemnity
forthcoming
forthcoming
–
Insured margin = select
Insured margin = select
total
total
contract margin −
contract margin −
deductible ($/cwt)
deductible ($/cwt)
–
Indemnity amount = Insured −
Indemnity amount = Insured −
actual
actual
margin
margin
Only
Only
one
one
indemnity calculation per contract
indemnity calculation per contract
regardless
regardless
of contract length
of contract length
Indemnity determination made
Indemnity determination made
after
after
last actual
last actual
contract price published by
contract price published by
RMA
RMA
regardless
regardless
of
of
contract length
contract length
October 3, 2024
10
The National Program on Dairy Markets and Policy
LGM
LGM
: An Overview
: An Overview
•
LGM
LGM
purchased on last business Friday of
purchased on last business Friday of
each month
each month
if funds available
if funds available
–
Friday, 4:30 PM (Central) → 8:00 PM Saturday
Friday, 4:30 PM (Central) → 8:00 PM Saturday
–
Potential for 12 contract offerings/year
Potential for 12 contract offerings/year
•
Multiple contracts can cover milk marketings
Multiple contracts can cover milk marketings
in months previously protected
in months previously protected
–
Total coverage can not exceed 100% of an
Total coverage can not exceed 100% of an
operation’s approved maximum target
operation’s approved maximum target
marketings
marketings
for that particular month
for that particular month
October 3, 2024
11
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
•
How do
How do
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
compare?
compare?
October 3, 2024
12
Is sign-up mandatory?
Can a producer purchase both
MPP-
MPP-
Dairy
Dairy
and
LGM
LGM
?
The National Program on Dairy Markets and Policy
October 3, 2024
13
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
What is the range of margins protected?
What is the contract coverage period?
The National Program on Dairy Markets and Policy
October 3, 2024
14
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
When can contracts be purchased?
The National Program on Dairy Markets and Policy
October 3, 2024
15
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
How much milk can be insured?
The National Program on Dairy Markets and Policy
October 3, 2024
16
When are payments/indemnities determined?
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
October 3, 2024
17
How do premiums compare?
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
October 3, 2024
18
To what degree are these programs subsidized?
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
October 3, 2024
19
When are user fees/premiums due?
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
October 3, 2024
20
What are program feed ration characteristics?
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and
and
LGM
LGM
October 3, 2024
21
What prices are used in program calculations?
The National Program on Dairy Markets and Policy
Comparison of
Comparison of
MPP-Dairy
MPP-Dairy
and L
and L
GM
GM
October 3, 2024
22
How can
LGM
LGM
(
MPP-Dairy
MPP-Dairy
)
user’s
transition to use of
MPP-Dairy
MPP-Dairy
(
(
LGM
LGM
)
)
?
The National Program on Dairy Markets and Policy
Use of
Use of
MPP-Dairy
MPP-Dairy
and
and
Other Risk Management Tools
Other Risk Management Tools
•
Factors when choosing use of MPP-Dairy
and other margin risk management systems:
–
How much protection do you need?
If need more protection than offered via MPP-Dairy
may need to consider other risk management systems
–
Herd expansion
–
High component milk
–
What is the cost?
October 3, 2024
23
The National Program on Dairy Markets and Policy
Use of
Use of
MPP-Dairy
MPP-Dairy
and
and
Other Risk Management Tools
Other Risk Management Tools
•
Factors when choosing use of MPP-Dairy
and other margin risk management systems:
–
What is farm’s margin basis and basis volatility?
What is the relationship between a farm’s mailbox
margin and USDA’s value?
If need $6.50 on-farm margin to cover variable costs
how does this translate to MPP-Dairy margin: $7.50,
$5.75, etc. ?
How likely a farm’s margin declines much more than
USDA benchmark margin?
October 3, 2024
24
The National Program on Dairy Markets and Policy
Contact Information
Contact Information
25
Professor Brian W. Gould
bwgould@wisc.edu
(608)263-3212
Dairy Marketing and Policy (
DMaP
)
group
MPP-Dairy
website:
www.dairymarkets.org/mpp
October 3, 2024
The National Program on Dairy Markets and Policy
MPP-Dairy enrollment does not impact using other risk management systems, with exceptions for Livestock Gross Margin for Dairy (LGM). You can still forward contract farm milk and purchase feed while using MPP-Dairy. Options-based strategies like Class III puts and feed-based calls can establish an IOFC floor. Explore the use of MPP-Dairy along with other margin risk management tools to protect milk values and feed costs effectively.
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Presentation Transcript
Use of MPP-Dairy vs. Other Margin Risk Management Systems: How Do They Compare? Prof. Brian W. Gould Department of Agricultural and Applied Economics University of Wisconsin-Madison University of Wisconsin Extension PowerPoint Presentation: www.dairymarkets.og/MPP/PowerPoint/Option_LGM_MPP.pptx The National Program on Dairy Markets and Policy 1
MPP-Dairy and Use of Other Margin Risk Management Systems MPP-Dairy enrollment: No impact on ability to use other risk management systems except for Livestock Gross Margin for Dairy (LGM) Cannot participate in both programs Use of LGM impacts procedures to enroll in MPP-Dairy if desired Does impact complementary use of other systems The National Program on Dairy Markets and Policy October 3, 2024 2
MPP-Dairy and Use of Other Margin Risk Management Systems Can still Forward contract farm milk with processor (except Class I) and purchased feed from supplier Continue to use futures and/or options if desired If use MPP-Dairy may want to protect Additional milk component values: MPP-Dairy assumption that milk has average quality and price Uninsured milk: Slow APH growth starting after enrollment 90% maximum program coverage The National Program on Dairy Markets and Policy October 3, 2024 3
Margin Risk Management: Options Based Before we talk about MPP-Dairy and LGM lets quickly review a simple options based strategy for establishing an IOFC floor Class III put: Establishes minimum milk value Feed-based equivalent call: Establishes maximum feed cost ($/cwt milk) Corn SBM and SBM equivalents i.e., Convert feed to corn The National Program on Dairy Markets and Policy October 3, 2024 4
Margin Risk Management: Options Based Milk revenue floor $/cwt $P* Class III Put Strike Price IOFC** > IOFC < IOFC* Min. IOFC IOFC* $C* Feed Call Strike Price IOFC** Feed cost ceiling $P* $C* Market Price/Cost ($/cwt milk) The National Program on Dairy Markets and Policy October 3, 2024 5
Margin Risk Management: Options Based Problems with this strategy Could by expensive especially in volatile markets For small operations, contract sizes may be problematic 200,000 & 100,000 lb Class III (options) 110/55 cow herds assuming 22,000 lbs/cow 5,000 bu Corn & Soybeans 100 tons Soybean Meal May not be able to undertake desired strategy due to relatively thin Class III options market Someone must be willing to sell the put option The National Program on Dairy Markets and Policy October 3, 2024 6
Margin Risk Management: LGM MPP-Dairy sign-up: Can sign-up anytime over life of Farm Bill during designated sign-up periods After sign-up, enrolled until end of 2018 Before initial sign-up producers may want to evaluate merits of MPP-Dairy vs. LGM Lets quickly review LGM and then compare each programs characteristics The National Program on Dairy Markets and Policy October 3, 2024 7
LGM: An Overview LGM used to manage IOFC volatility Establishes minimum IOFC similar to above put/call options strategy No options actually purchased Markets only used as information source No minimum size limit unlike options contracts Coverage Upper limit: 240,000 cwt over 10 mo. or within a single insurance year Premium not due until after 11-month insurance period regardless of number of insured months Known subsidized producer premiums and direct payments to insurance providers The National Program on Dairy Markets and Policy October 3, 2024 8
LGM: An Overview LGM is customizable with respect to: Number of months insured by a contract: 1 10 % of monthly marketings insured: 0 100% % insured can vary across month Deductible chosen: $0 $2.00/cwt Amt. margin falls below target before indemnity created Direct producer premium subsidy: 18% 50% Subsidy increases with higher deductible Program declared ration Given the above farm specific premiums The National Program on Dairy Markets and Policy October 3, 2024 9
LGM: An Overview If insured margin greater than actual margin for entire contract indemnity forthcoming Insured margin = select totalcontract margin deductible ($/cwt) Indemnity amount = Insured actual margin Only one indemnity calculation per contract regardless of contract length Indemnity determination made after last actual contract price published by RMA regardless of contract length The National Program on Dairy Markets and Policy October 3, 2024 10
LGM: An Overview LGM purchased on last business Friday of each month if funds available Friday, 4:30 PM (Central) 8:00 PM Saturday Potential for 12 contract offerings/year Multiple contracts can cover milk marketings in months previously protected Total coverage can not exceed 100% of an operation s approved maximum target marketings for that particular month The National Program on Dairy Markets and Policy October 3, 2024 11
Comparison of MPP-Dairy and LGM How do MPP-Dairy and LGM compare? Is sign-up mandatory? MPP-Dairy LGM Program is voluntary Program is voluntary Can a producer purchase both MPP- Dairy and LGM ? MPP-Dairy LGM ------- Not Allowed once signed up The National Program on Dairy Markets and Policy October 3, 2024 12
Comparison of MPP-Dairy and LGM What is the range of margins protected? MPP-Dairy LGM Margin range: $4 to $8/cwt in $0.50 increments Range does not change with milk or feed market conditions What is the contract coverage period? Infinite coverage levels Determined by futures market settlement prices at sign-up MPP-Dairy LGM Annual if existing producer Prorated for new operation or 2014/15 transitioning LGM user Producer determined 2 11 months after purchase The National Program on Dairy Markets and Policy October 3, 2024 13
Comparison of MPP-Dairy and LGM When can contracts be purchased? MPP-Dairy LGM May be purchased once a year during designated sign-up period 2014 15: Sep 2nd Nov 28th 2014 2016 18: June 1 Last business day of August Once signed-up, in program until end of 2018 Offered last business Friday monthly starting at 4:30 CDT Producers may sign up 12 times per year given funding availability Offered on first come, first served basis The National Program on Dairy Markets and Policy October 3, 2024 14
Comparison of MPP-Dairy and LGM How much milk can be insured? MPP-Dairy LGM 0% 100% approved target marketings No growth limit on insured milk marketings % milk covered can vary across months Multiple contracts can be used to cover a month s marketings until 100% insured if desired 25% 90% of operation sAPH Annual increase in APH equals aggregate dairy industry growth rate % of milk covered is the same for all months The National Program on Dairy Markets and Policy October 3, 2024 15
Comparison of MPP-Dairy and LGM When are payments/indemnities determined? MPP-Dairy LGM Six bimonthly payment determinations: Jan/Feb Mar/Apr May/Jun Jul/Aug Sept/Oct Nov/Dec Only 1 indemnity determined per contract regardless of length After last insured month s actual price announced Period varies with contract specification and months insured The National Program on Dairy Markets and Policy October 3, 2024 16
Comparison of MPP-Dairy and LGM How do premiums compare? MPP-Dairy LGM Fixed rate schedule 25% discount for 2014/15 Vary with (i) margin protected and (ii) milk amount insured Same premium for same margin target and premium tier for entire 2014 Farm Bill life Do not change with market conditions Designed to be actuarially fair Premium = 1.03 times expected indemnity at signup Premium independent of insured amt. Vary with (i) market conditions; (ii) declared ration; (iii) deductible; and (iv) margin protected Premiums vary across farms and over time for same margin May change with market conditions, ceteris paribus, for same margin target The National Program on Dairy Markets and Policy October 3, 2024 17
Comparison of MPP-Dairy and LGM To what degree are these programs subsidized? MPP-Dairy LGM 100% subsidy @ $4.00/cwt > $4.00: Implicit subsidy depends on milk/feed markets Program not self-financing Subsidy changes given market conditions, margin target and APH Premiums subsidized where % subsidy depends on deductible $0 18% $1.00 48% $2.00 50% Additional subsidy for A&O to insurance providers: Approx. 20% of pre-subsidized premium The National Program on Dairy Markets and Policy October 3, 2024 18
Comparison of MPP-Dairy and LGM When are user fees/premiums due? MPP-Dairy LGM 2 alternatives: 100% at sign-up; or 25% min. at sign-up, remainder by June 30th of insured year Fees subtracted from any forthcoming payment Premium due 11 months after purchase regardless of contract length Premium subtracted from any forthcoming indemnity The National Program on Dairy Markets and Policy October 3, 2024 19
Comparison of MPP-Dairy and LGM What are program feed ration characteristics? MPP-Dairy Fixed feed ration All months All operations Feed costs still vary monthly All feed assumed purchased LGM Operation specific rations May include only purchased feed if desired Ration can vary across months under a single contract $Cost/cwt may vary across months within a contract The National Program on Dairy Markets and Policy October 3, 2024 20
Comparison of MPP-Dairy and LGM What prices are used in program calculations? MPP-Dairy LGM Simple 3-day average of CME futures final daily settlement prices for Class III milk, Corn, and SBM Expected prices: Calculated at sign-up Actual prices: Set when futures contracts expire Average U.S. price received for All-Milk, Corn, and Alfalfa Hay (USDA, Ag Prices Report) Only final prices used SBM valued at Central Illinois /Decatur (Rail) reported by USDA, AMS The National Program on Dairy Markets and Policy October 3, 2024 21
Comparison of MPP-Dairy and LGM How can LGM (MPP-Dairy)user s transition to use of MPP-Dairy (LGM)? MPP-Dairy Once purchased, MPP-Dairy contract holders cannot purchase LGM LGM 2014/15: Contract holders can transition to MPP-Dairy with coverage starting after fulfilling LGM contract After 2015: Cannot have active LGM contract for months covered by desired MPP-Dairy contract (i.e., entire year) The National Program on Dairy Markets and Policy October 3, 2024 22
Use of MPP-Dairy and Other Risk Management Tools Factors when choosing use of MPP-Dairy and other margin risk management systems: How much protection do you need? If need more protection than offered via MPP-Dairy may need to consider other risk management systems Herd expansion High component milk What is the cost? The National Program on Dairy Markets and Policy October 3, 2024 23
Use of MPP-Dairy and Other Risk Management Tools Factors when choosing use of MPP-Dairy and other margin risk management systems: What is farm s margin basis and basis volatility? What is the relationship between a farm s mailbox margin and USDA s value? If need $6.50 on-farm margin to cover variable costs how does this translate to MPP-Dairy margin: $7.50, $5.75, etc. ? How likely a farm s margin declines much more than USDA benchmark margin? The National Program on Dairy Markets and Policy October 3, 2024 24
Contact Information Professor Brian W. Gould bwgould@wisc.edu (608)263-3212 Dairy Marketing and Policy (DMaP) group MPP-Dairy website: www.dairymarkets.org/mpp The National Program on Dairy Markets and Policy October 3, 2024 25
