Hedging with Futures and Options Under a Truncated Cash Price Distribution

Posted: 23 Oct 2000

See all articles by Steven D. Hanson

Steven D. Hanson

Michigan State University - Department of Agricultural Economics

Robert J. Myers

Michigan State University - Department of Agricultural Economics

James H. Hilker

Michigan State University - Department of Agricultural Economics

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 Programs, Futures, Hedging, Options, Truncation

JEL Classification: Q14

Suggested Citation

Hanson, Steven D. and Myers, Robert J. and Hilker, James H., Hedging with Futures and Options Under a Truncated Cash Price Distribution. Journal of Agriculture and Applied Economics, Vol. 31, Issue 3, December 1999. Available at SSRN: https://ssrn.com/abstract=237096

Steven D. Hanson (Contact Author)

Michigan State University - Department of Agricultural Economics ( email )

East Lansing, MI 48824
United States
517-353-1870 (Phone)
517-432-1800 (Fax)

Robert J. Myers

Michigan State University - Department of Agricultural Economics ( email )

East Lansing, MI 48824
United States
517-432-3649 (Phone)

James H. Hilker

Michigan State University - Department of Agricultural Economics ( email )

East Lansing, MI 48824
United States

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