Understanding Dairy Futures and Options

Farmers wishing to learn more about price risk management using NZX Futures and Options can access a growing range of educational materials, including:

Useful Resources

• NZX NZ Milk Price Futures booklet
• NZX NZ Milk Price Options booklet

What are Futures?

A futures contract is a commitment to make or take delivery of a specific quantity and quality of a given asset or a cash difference at a specific date in the future at a price agreed today. All terms of the contract are standardised, other than the price.

The benefits of trading futures include virtual elimination of counterparty credit risk, ability to set prices in advance and an ability to adjust volume in the open market. NZX Dairy Futures are cash settled, meaning greater flexibility and facilitating increased volume from speculators and hedgers.

Cash settlement of a futures contract means participants don't have to implement complicated delivery mechanisms or risk having to make, or take, delivery of a product when trading in the futures market. Cash settlement is particularly preferable for dairy commodities where food safety criteria, and the actual delivery process, are complex and not globally standardised.

Learn more about Futures contracts in NZX's educational video below:

What is margin?

Margin is a unique characteristic of all futures contracts. It is the amount of money that you must deposit with your broker when you open a futures position.

There are two types of margin that the exchange requires for trading on futures positions, Initial Margin, and Variation Margin, also known as Mark-to-market.

Learn more about margin on futures contracts in NZX's educational video below:

What are Options?

An option is the right, but not the obligation, for the purchaser, to buy or sell an underlying asset at a price agreed today at a set date in the future.

There are five key components of an option:

Underlying Asset

The underlying asset of an option is what is delivered if the option is exercised. This could be shares or commodities or a futures contract. The NZX WMP options deliver WMP futures.

Type

There are two types of options:

• A call option gives the holder (purchaser) of an option, the right but not the obligation, to buy the underlying asset at the exercise price; and
• A put option gives the holder (purchaser) of an option, the right but not the obligation, to sell the underlying asset at the exercise price.

Exercise Price (Strike Price)

This is the price you receive, or pay for the underlying asset (i.e. WMP Futures) when you exercise your option. For example, if you are the buyer of a US$4,500 WMP call option, when you exercise that option you are entitled to purchase a WMP Futures contract from the option seller at a price of $4,500.

Expiry Date

This is the date at which all unexercised options expire. Each option has a range of different expiry months to choose from. As one month expires a new option with a later expiry date is created.

Premium

Option buyers pay a price for purchasing an option known as the premium.

Learn more about Option contracts in NZX's educational video below: