Seminars held at National Fieldays by NZX Agri were well attended, with keen interest from both farmers and agribusiness professionals who are trying to figure out exactly how these products work, and whether they will be beneficial for their businesses.
The brokers who ran the seminars were impressed by the level of attendance and the willingness of farmers to learn about these financial tools. Each day a different broker presented.
Mike McIntyre and Harry Hewitt from First NZ Capital were first off the block on Wednesday, followed by Nigel Brunel from OMF on Thursday. Friday’s session was presented by FC Stones’ Liam Fenton from Ireland who was impressed by the eagerness of farmers to embrace new products and tools and the resilience shown by farmers during the current downturn.
Brokers were quick to remind attendees futures and options are complex tools and it’s important to fully understand how they work before trading them.
Unlike fixed milk price schemes offered by milk processors, futures and options are a separate market operated by NZX and accessed via a broker.
By using milk price futures or options you are effectively offsetting your risk in the physical market for milk – the price your milk processor pays you – by entering a financial contract in a separate market.
The markets are linked because NZX milk price futures contracts are cash-settled against Fonterra’s final milk price. The concept of using milk price futures to lock in a milk price was pretty well understood by farmers attending the seminars. Questions focused on the practicalities of trading and the associated costs.
To trade a futures contract you must open an account with a broker. There are a number of brokers to choose from, which are listed on the NZX Futures website (www.nzxfutures.com). The brokers warned opening an account takes a bit of time because there’s a raft of forms that need to be completed and identities need to be verified.
Before jumping in and trading futures the brokers stressed the need to decide if futures are the right tool for you. What is your attitude to risk? Are you happy to forego upside in the milk price in order to obtain certainty? Will your business benefit from milk price certainty?
Ideally you will have a risk management plan for your business – whether it’s a written document or a plan stored in your head. It really doesn’t matter what form it’s in as long as you have a plan and you stick to it – or you make a conscious decision to change it.
If you’re looking for a risk management tool that means you don’t have to forego any lift in the milk price to protect yourself from a drop, milk price options, rather than futures, might be the tool you are looking for.
Options started trading on the NZX market on June 30. In the case of options you pay a price upfront – known as a strike price – for the right but not the obligation to a futures contract. In the case of options there are no margin requirements or ongoing costs but a brokerage fee will apply.
The fees brokers charge will vary. Fees will typically be charged per contract traded, ie per 6000kg milksolids. The fee your broker quotes will normally include the $3 per-lot transaction fee that NZX charges.
In the case of futures you will also be subject to margin requirements. As the margin is basically refunded at the end of the contract, assuming the price didn’t move, the margin cost really relates to how much it will cost you to fund this during the period the contract is open, ie your interest rate costs or your opportunity cost of having these funds tied up. If milk prices rise you will be required to post additional margin – known as variation margin.
The initial margin requirements will also vary between brokers. NZX has an underlying initial margin fee that is currently set at about 6% of the value of the contract.
Initial margin requirements typically range from 5% to 15%. The initial margin is a bit like a bond – it is returned to you at the end of the contract after it is adjusted for any gains or losses made.
The milk price futures contract is valued daily and based on this value you might have to post additional margin – known as variation margin.
This situation would occur if the milk price futures price rises. If the milk price is trending down you will end up with excess margin that you can withdraw.
