This is known as basis risk . The less a producer or manufacturer knows about their basis, the greater the basis risk and the less effective are dairy futures and options as price risk management tools. Knowing the basis is also essential for a dairy producer to translate a dairy futures price into an expected cash milk price to be paid in the future. A milk is priced under a federal milk marketing order. Most milk that isn't price under a federal order is priced under a state order like California, for example.
Most basis risk is due to changes in premiums and discounts received.
Even in California, there is a strong relationship between the BFP and California producer milk prices. The role of basis risk when undertaking a hedging strategy can be seen in the Understanding Hedging section. Click here to return to this section. Basis is calculated by cash price minus futures price. For farm milk, the mailbox price minus the BFP futures price is the basis.