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Hedging with Futures and Options under a Truncated Cash Price Distribution

Published online by Cambridge University Press:  28 April 2015

Steven D. Hanson ,
Robert J. Myers  and
James H. Hilker
Steven D. Hanson
Affiliation:
Department of Agricultural Economics, Michigan State University, East Lansing, Michigan
Robert J. Myers
Affiliation:
Department of Agricultural Economics, Michigan State University, East Lansing, Michigan
James H. Hilker
Affiliation:
Department of Agricultural Economics, Michigan State University, East Lansing, Michigan
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Abstract

Many agricultural producers face cash price distributions that are effectively truncated at a lower limit through participation in farm programs designed to support farm prices and incomes. For example, the 1996 Federal Agricultural Improvement Act (FAIR) makes many producers eligible to obtain marketing loans which truncate their cash price realization at the loan rate, while allowing market prices to freely equilibrate supply and demand. This paper studies the effects of truncated cash price distributions on the optimal use of futures and options. The results show that truncation in the cash price distribution facing an individual producer provides incentives to trade options as well as futures. We derive optimal futures and options trading rules under a range of different truncation scenarios. Empirical results highlight the impacts of basis risk and yield risk on the optimal futures and options portfolio.

Keywords

farm programsfutureshedgingoptionstruncation
Type
Articles
Information
Journal of Agricultural and Applied Economics , Volume 31 , Issue 3 , December 1999 , pp. 449 - 459
Copyright
Copyright © Southern Agricultural Economics Association 1999

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