NZX dairy derivatives' record month in May

NZX had a record trading month for dairy derivatives in May, as increased liquidity and uncertainty around dairy prices stoked demand for options.

The NZX Global Dairy Derivatives market traded 18,225 lots across futures and options in May, beating the previous record of 14,723 in August last year. Some 65% of the May trades were in options, compared with just 15% in August.

NZX launched the dairy derivatives market in October 2010 with the aim of becoming the global hub for trading tied to New Zealand's biggest export commodity. Derivative volumes so far this year are up 180% on a year earlier as increased liquidity draws in more trading and as demand for risk management products rises in the face of uncertainty about the outlook for dairy prices following the end of European milk quotas, Russia's trading ban and weak Chinese demand.

"There is a relatively high level of uncertainty over where the market is going," said Kathryn Jaggard, head of derivatives at NZX. "We want to be able to offer New Zealand firms and global firms the ability to mitigate that risk which is now becoming very apparent in the market. The prospects for our market are very good. The market is really going in the right direction at a good pace. We would like to see that upward curve continue."

The dairy derivatives market started with whole milk powder futures and has since added skim milk powder, anhydrous milk fat and butter futures. Whole milk powder options were added in November 2011 but didn't trade until June 2014. The recent uptick in options trading means customers are getting more creative about strategies to manage risk, Ms Jaggard said.

"Options are one step further on than using futures," Ms Jaggard said. "What the options do is provide additional flexibility in that you can create a minimum downside but you can still benefit from upside in the market, whereas with futures you are just locking in one price. No matter which way the market goes, that's the price you get."

"Options really only exist where you have a liquid enough futures market to support trading in options because you really do need a reasonable amount of activity in the futures market to support trading in the options market," she said. "The story in derivatives markets is always liquidity begets liquidity."

NZX is now considering offering skim milk powder options, she said.

"Firms are becoming more comfortable with our market because they see that it is a viable market and they can get in and out of it successfully."

Ms Jaggard said as many as 10 additional dairy customers, including product buyers, sellers and distributors, from North America and Asia were likely to join the market following talks at the American Dairy Products Institute annual conference in Chicago which she attended in April. She declined to say how many customers were currently in the market.

"There is definitely a need out there for risk management," she said. "The ups and downs of milk prices are becoming untenable for a lot of firms and so dairy is moving into that realm of other commodities like coffee, cocoa, sugar etc that have had risk management tools for a lot of years and dairy is moving into that zone now where it's difficult to function without risk management."

(BusinessDesk)