August 1, 2001 | By: Aimee D. Heald
LEXINGTON, KY.

Many dairy producers probably have noticed milk prices become more variable over the years. Some of the largest month-to-month price drops in history have occurred during this time. Large price changes can make dairy farming more risky than in the past. Fortunately University of Kentucky College of Agriculture Dairy Specialist, Bill Crist, said there are tools to help producers manage price risk.

“One of the tools available is put options,” he said. “Put options are best thought of as price insurance.”

Crist said put options function almost like car insurance. By paying a premium, dairy producers are able to lock in a floor price for their milk. If prices fall below that locked level, the put option insurance kicks in and producers receive a payment. If milk prices stay the same or rise, the insurance goes unused and producer’s put options expire worthless.

“Just like auto insurance, dairy producers are better off if they don’t receive payment from their put option,” Crist added.

Put options can be bought at several different price floors. The closer the price floor is to the current milk price, the higher the premium. Different price floors are comparable to the deductible on auto insurance. A larger deductible may cost less, but also is less likely to pay out. Dairy farmers can buy put options on Class III or IV milk for any month, up to 12 months in advance.

The Risk Management Agency of the USDA has established a Dairy Option Pilot Program to help dairy farmers become more comfortable with put options. The DOPP is authorized under the Federal Agriculture Improvement Act of 1996.

“In Kentucky there are now 12 counties eligible to participate in DOPP training, including Adair, Barren, Fleming, Green, Hart, Lincoln, Marion, Mason, Metcalf, Nelson, Pulaski and Shelby,” Crist said. “Even though DOPP only covers 12 counties at this time, it will likely be expanded to include others.”

A farmer participating in DOPP only has to pay 20 percent of the cost of a put option. The RMA pays the other 80 percent as well as most of the broker fees. To participate, a producer must have attended a training workshop.

“The USDA appears to want farmers to practice risk management without the use of price supports,” Crist said. “Put options are a useful risk management tool even without the USDA cost share. However, when the USDA is willing to pay most of your insurance premium, dairy farmers should give these risk management tools a closer look.”

Contact: 

Bill Crist 859-257-7543