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Strategic use of futures and options by commodity processors

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  • Bullock, David W.
  • Wilson, William W.
  • Dahl, Bruce L.

Abstract

In this study, the strategic impacts of input-output price relationships on end-users' demands for futures and/or options are analyzed. An analytical model is developed based on mean-variance utility and extended to account for the impact of output prices and the inclusion of both futures and/or call options in the portfolio. This study makes several contributions to the literature on risk management in agriculture. First, its focus is on end-users and captures their unique characteristics. Second, it explicitly captures the correlation between input-output prices on hedging strategies. Finally, it incorporates options into a portfolio model. The analytic model was applied to the bread baking industry, an important agribusiness processor, which is interesting because of the relation between wheat prices, the primary ingredient, and bread prices. We show the optimal portfolio of futures and options and illustrate how this varies with several critical variables.
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Suggested Citation

  • Bullock, David W. & Wilson, William W. & Dahl, Bruce L., 2007. "Strategic use of futures and options by commodity processors," International Review of Economics & Finance, Elsevier, vol. 16(4), pages 578-591.
    • Handle: RePEc:eee:reveco:v:16:y:2007:i:4:p:578-591
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    References listed on IDEAS

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    1. Wolf, Avner, 1987. "Optimal hedging with futures options," Journal of Economics and Business, Elsevier, vol. 39(2), pages 141-158, May.
    2. Leland L. Johnson, 1960. "The Theory of Hedging and Speculation in Commodity Futures," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 27(3), pages 139-151.
    3. Harvey Lapan & Giancarlo Moschini & Steven D. Hanson, 1991. "Production, Hedging, and Speculative Decisions with Options and Futures Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 73(1), pages 66-74.
    4. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    5. Ronald I. McKinnon, 1967. "Futures Markets, Buffer Stocks, and Income Stability for Primary Producers," Journal of Political Economy, University of Chicago Press, vol. 75(6), pages 844-844.
    6. Bullock, David W. & Hayes, Dermot J., 1993. "The private value of having access to derivative securities: An example using commodity options," International Review of Economics & Finance, Elsevier, vol. 2(3), pages 233-249.
    7. Bullock, David W. & Hayes, Dermot J., 1992. "Speculation and Hedging in Commodity Options: A Modification of Wolf's Portfolio Model," Staff General Research Papers Archive 486, Iowa State University, Department of Economics.
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    Cited by:

    1. William W. Wilson & William E. Nganje & Cullen R. Hawes, 2007. "Value-at-Risk in Bakery Procurement," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 29(3), pages 581-595.
    2. Songjiao Chen & William Wilson & Ryan Larsen & Bruce Dahl, 2016. "Risk Management for Grain Processors and “Copulas”," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 64(2), pages 365-382, June.

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