Class III Milk Futures: Pricing Cheese Milk

Key Takeaways

• Class III milk futures trade on the CME in 200,000 pound lots, expressed as 2,000 hundredweight.
• One tick of one cent per hundredweight equals 20 dollars per contract, and the contract is cash settled.
• The price is set by USDA from cheese and whey values, so it is not a freely negotiated milk price.
• Reading milk as one market is wrong, since USDA splits raw milk into separate classes by end use.

What It Is

The Class III milk futures contract trades on CME Group under the symbol DC. Each contract covers 200,000 pounds of milk, expressed as 2,000 hundredweight, abbreviated cwt. There is no physical delivery. All open contracts settle in cash against the USDA announced Class III price.

Prices are quoted in U.S. dollars per hundredweight. The minimum price move is one cent per cwt, which equals 20 dollars per contract. Each futures contract is valued at 2,000 times the USDA Class III price, so the announced monthly price determines the final settlement.

The Intuition

Raw milk is the same liquid leaving the farm, but the U.S. system prices it by what it becomes. Under federal milk marketing orders, USDA assigns milk to classes by end use. Class III is the milk used to make cheese, and it is the most actively traded class because cheese is such a large outlet.

A dairy farmer cannot store fluid milk, so the price received is exposed to whatever the market does that month. Class III futures let the farmer lock that price in advance. A cheesemaker faces the mirror risk on the buying side and can hedge the same way.

How Class III Milk Futures Work

The contract settles to a USDA calculated number, not a private negotiation. USDA derives the Class III price each month from surveyed wholesale prices for cheese and dry whey, applying a formula that converts those product values back into a milk price per hundredweight.

Contract value = 2,000 cwt x USDA Class III price per cwt

Because the settlement price comes from cheese and whey values, Class III milk futures move closely with cheese prices. A trader who expects cheese to rise will expect Class III to rise too. That tight link is why the cheese block contract and Class III milk are often watched together.

The contract has a daily price limit of 0.75 dollars per cwt above or below the prior settlement, which is removed in the expiring contract once it enters its final stretch. Cash settlement against a published government price means there is no warehouse, no delivery, and no basis to a single location.

Worked Example

Suppose the front month Class III milk contract trades at 20 dollars per cwt. One contract is 2,000 cwt, so its value is:

20 dollars x 2,000 cwt = 40,000 dollars per contract

Now consider a dairy farm that will ship the equivalent of 1,000,000 pounds of Class III milk over the next month, which is 5 contracts. To lock the price, the farm sells 5 contracts. If the announced Class III price comes in 1.50 dollars per cwt lower, the short futures position gains:

1.50 dollars x 2,000 cwt x 5 contracts = 15,000 dollars

That gain offsets most of the lower price the farm now receives for its milk. The hedge works through the published USDA price, so there is nothing to deliver.

Common Mistakes

1. Treating milk as one price. USDA splits raw milk into classes by use. Class III is cheese milk, and it can diverge from the prices of other classes.

2. Forgetting it tracks cheese. The settlement formula is built from cheese and whey values, so cheese price moves drive Class III almost directly.

3. Expecting delivery. The contract is cash settled to a USDA price. There is no milk to deliver and no warehouse basis.

4. Ignoring the announcement schedule. Final settlement waits for the USDA monthly Class III announcement, so the expiring contract settles on a published number, not the screen.

5. Overlooking feed and herd costs. Milk margins depend on feed prices too. Programs that hedge the milk to feed spread exist for that reason.

Frequently Asked Questions

What are Class III milk futures in simple terms? They are standardized contracts that lock in the price of milk used to make cheese, traded on the CME in 200,000 pound lots. They settle in cash against a monthly USDA price.

How do Class III milk futures affect investment decisions? Dairy farmers and cheesemakers use them to hedge milk price swings, while traders use them to take a view on cheese driven milk values. A price move changes the revenue or cost for anyone exposed to cheese milk.

What is a real-world example of Class III milk futures moving? When wholesale cheese prices rise sharply, Class III milk futures climb with them, because the USDA settlement price is calculated directly from cheese and whey values.

How can investors use Class III milk futures effectively? Watch cheese block prices, which lead Class III through the settlement formula, and track feed costs to judge the milk margin. Plan around the monthly USDA announcement that sets final settlement.

How is Class III milk different from cheese block futures? Class III milk prices the raw milk that goes into cheese and settles to a USDA derived milk price, while cheese block futures price the finished 40 pound cheddar blocks directly. One is the input, the other the product.

Sources

1. CME Group. "Class III Milk Futures Contract Specs." https://www.cmegroup.com/markets/agriculture/dairy/class-iii-milk.contractSpecs.html
2. CME Group. "Class III Milk Rulebook, Chapter 52." https://www.cmegroup.com/rulebook/CME/II/50/52/52.pdf
3. CME Group. "Introduction to Hedging with Dairy Futures and Options." https://www.cmegroup.com/trading/agricultural/files/introduction-to-dairy-futures-and-options.pdf
4. USDA Agricultural Marketing Service. "CME Group Dairy Pricing." https://www.ams.usda.gov/sites/default/files/media/FMMO_CME_1.pdf

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.