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'Jittery' market piles into record volume of dairy derivatives after steep price drop at GDT auction

Thursday 5th July 2018

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Unexpectedly weak prices for whole and skim milk powder at this week's Global Dairy Trade auction have seen market participants pile into a record volume of dairy derivatives on the NZX, with most of the jump in options to buy or sell the products.

The record volume was 6,415 lots on July 3, according to NZX Dairy Derivatives data. That beat the previous record set in 2015 of 5,994. At the Global Dairy Trade auction overnight last Tuesday, prices fell, led by an unexpectedly big decline in whole milk powder. The auction was held after Fonterra Cooperative Group, one of the biggest market participants, released production figures showing its New Zealand milk collection for May was up 7 percent from a year earlier to 71 million kilograms and it forecast a 1.3 percent increase for the 2018/19 season.

Whole milk powder sank 7.3 percent to US$2,905 a tonne and skim milk powder shed 4.6 percent to US$1,913 a tonne, prompting AgriHQ dairy analyst Amy Castleton to say it looked like the market "had the jitters, especially for whole milk powder".

"Yesterday the market had a record day. People wanted to jump in and manage their risk," said Nigel Brunel, director of institutional commodities at OMF. "GDT went down and that made the market more volatile. It was more than I expected but there seems to be a lot of milk out there globally and New Zealand is setting itself up for a good season."

Some 4,000 contracts were in options, the biggest volume in at least three months, based on NZX data. A similar volume of futures contracts traded a week earlier, also a three-month high. It was the busiest day for options trading since May 2015. The contracts are for one metric tonne for GDT-based contracts and 6,000 kgMS for NZ milk price contracts.

Nick Morris, NZX head of derivatives, said it was "pleasing to see record levels of activity" in dairy derivatives. "Higher volatility at the recent GDT auction is driving large volumes of trade."

NZX said its data showed the majority of options traded yesterday were at strikes of $2,900 and $3,000. Call options, which give the owner the right to buy the underlying commodities at an agreed price, were traded at $3,000 and puts, an option to sell at a specified rate and time, at $2,900. It added that some options "appear to be trading as structures". It said participants typically use options as insurance should the price move against them, without having to be committed to such a position.

Traders use contract structures to suit their needs including a collar, where the holder seeks to put a cap and a floor on the price. Within that, there's a 'long collar', where the trader buys a call option and sells a put option, and a 'short collar', where they take the opposite position.

NZX's June metrics show that the notional value of dairy derivatives traded rose 16 percent from June 2017 to $132 million. There were 26,417 futures lots traded, up 10 percent, and 7,332 options lots, up almost 30 percent. The 'options to futures ratio' rose 18 percent to about 28 percent.

According to Brunel, the participants in the market are also participants in the dairy sector and are hedging their actual risks and potentially offsetting positions elsewhere, such as being long in the futures market or to offset risks in the actual cash market. OMF's clients do seek structured positions and Brunel declined to comment on actual trading.

Market participants range from producers and sellers of milk to distributors and buyers of dairy products. Up until this latest week, volatility in the market had actually reduced, Brunel said.


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