THE dairy sector has been one of the industries hardest hit by the current trade embargoes between Russia and the European Union. Faced with a glut of cheese, European producers responded by turning milk not into cheddar or brie, but into less perishable skimmed-milk powder, prompting its wholesale price to drop by a third. Such price volatility can be damaging to all parts of the industry. Both farmers and food manufacturers, such as Nestlé and Danone, rely on a steady price to plan future production. In response, Euronext, a pan-European exchange, launched on April 14th several dairy derivatives aimed at those in the sector who want to hedge against such volatility, and at speculators who want to take on such risks.
In short, a derivative is a contract to buy or sell an underlying asset, index or security at a pre-agreed price in the future. For a farmer or food manufacturer, a derivative can form an insurance policy against future events such as bad weather or interest-rate rises. For a speculator, it can be a lucrative way of betting on whether prices will go up or down.
