Dairy producers confront increasing price risks from both inputs and outputs as the prices of milk, corn and soybean become more volatile in recent years. These risks significantly affect dairy producer's profit margin. This thesis proposes two futures contracts - milk-to-corn price ratio futures and milk-to-feed price ratio futures, both serving the purposes of protecting profit margin for dairy producers with only one hedging position. A theoretical framework is developed in which the stochastic processes and specifications of the two futures contracts are constructed and a simple farm profit model is established. Six scenarios of dairy farm profits are considered in this thesis. Optimal hedge ratios are derived based on commodity price levels for each hedging strategy. To examine the effectiveness of the proposed price ratio futures contracts, an empirical analysis is applied to a sample of 36 New York State dairy farms from 1996 to 2010, assuming each farm had routinely hedged. By qualitatively comparing the mean and variance of the calculated farm profits under the above six scenarios for each sample farm, milk-to-corn and milk-to-feed futures contracts would have been effective in managing price risks and protecting profit margin based on the sample.
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