IDEAS home Printed from https://ideas.repec.org/p/ags/aaea05/19271.html
   My bibliography  Save this paper

An Exploration of Market Pricing Efficiency: The Dairy Options Pilot Program

Author

Listed:
  • Buschena, David E.
  • McNew, Kevin

Abstract

Put options have been recommended as a substitute for price support programs (Gardner, 1977), and subsidized option purchases have received some support in lieu of subsidized insurance programs. Put options are an interesting alternative to price supports because their market-determined price levels allow for flexibility and adjustments to relevant current and expected market conditions. One difficulty with the use of put options as a substitute for commodity price supports is the relative thinness of these options markets for some commodities. Market thinness is defined here as the absence of traders willing to take the necessary opposite position in the market in lieu of a relatively large price premium, particularly for a large number of contracts. We explore empirically how a thin market responds when trading increases as a result of a subsidized put option program. USDA initiated the Dairy Options Pilot Program (DOPP) in 1999 in an effort to provide dairy producers with real-world experiences trading options (Vandeveer et al., 2003). Subsequently, additional rounds of DOPP occurred to give more producers a chance to participate. In total, over 1,300 producers bought 6,500 milk put option contracts through the DOPP program from 1999 to 2002. In contrast, over this four-year period total put options traded at the CME milk futures market totaled over 36,000 contracts. This, the volume from the DOPP program represented a fairly large share of total trading activity in the dairy put options market. An interesting feature of the subsidized milk options program is that dairy farmers may have made relatively little use of commodities markets due to the long-standing dairy price support programs. If this is the case, many of the dairy farmers making use of this subsidized options purchase program would have been relatively uniformed traders. Although DOPP may have increased trading volume, market performance may or may not have been enhanced due to the relative unfamiliarity with options trading by these dairy producers. We define a measure for observed options pricing efficiency using Black's formula in our study of the DOPP program, and statistically evaluate the size of the "error" in options pricing. We find that DOPP trades occurred at statistically significantly higher prices than did other trades, that DOPP volume had a price-reducing effect on other options trades, and that some brokers with large DOPP volume filled these orders at relatively large prices.

Suggested Citation

  • Buschena, David E. & McNew, Kevin, 2005. "An Exploration of Market Pricing Efficiency: The Dairy Options Pilot Program," 2005 Annual meeting, July 24-27, Providence, RI 19271, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  • Handle: RePEc:ags:aaea05:19271
    DOI: 10.22004/ag.econ.19271
    as

    Download full text from publisher

    File URL: https://ageconsearch.umn.edu/record/19271/files/sp05bu01.pdf
    Download Restriction: no

    File URL: https://libkey.io/10.22004/ag.econ.19271?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Bruce L. Gardner, 1977. "Commodity Options for Agriculture," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 59(5), pages 986-992.
    2. Ederington, Louis H. & Lee, Jae Ha, 1996. "The Creation and Resolution of Market Uncertainty: The Impact of Information Releases on Implied Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(4), pages 513-539, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Anderson, John D. & Hudson, Darren & Harri, Ardian & Turner, Steven C., 2007. "A New Taxonomy of Thin Markets," 2007 Annual Meeting, February 4-7, 2007, Mobile, Alabama 34826, Southern Agricultural Economics Association.
    2. Burdine, Kenneth H. & Maynard, Leigh J., 2012. "Risk Reduction of LGM-Dairy and its Potential Impact on Production," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124180, Agricultural and Applied Economics Association.
    3. Burdine, Kenneth H. & Kusunose, Yoko & Maynard, Leigh J. & Blayney, Donald P. & Mosheim, Roberto, 2014. "Livestock Gross Margin–Dairy: An Assessment of Its Effectiveness as a Risk Management Tool and Its Potential to Induce Supply Expansion," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 46(2), pages 1-12, May.
    4. Mosheim, Roberto & Blaney, Don & Burdine, Kenneth H. & Maynard, Leigh J., 2014. "Livestock Gross Margin-Dairy Insurance: An Assessment of Risk Management and Potential Supply Impacts," Economic Research Report 164606, United States Department of Agriculture, Economic Research Service.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Buschena, David E. & McNew, Kevin, 2005. "An Exploration of Market Pricing Efficiency: The Dairy Options Pilot Program," SCC-76 Meeting, 2005, March 31-April 2, Myrtle Beach, South Carolina 28726, SCC-76: Economics and Management of Risk in Agriculture and Natural Resources.
    2. Buschena, David E. & McNew, Kevin, 2004. "An Exploration of Market Pricing Efficiency During the Dairy Options Pilot Program," Agricultural Marketing Policy Papers 29159, Montana State University, Department of Agricultural Economics and Economics, Agricultural Marketing Policy Center.
    3. Gu, Chen & Kurov, Alexander & Wolfe, Marketa Halova, 2018. "Relief Rallies after FOMC Announcements as a Resolution of Uncertainty," Journal of Empirical Finance, Elsevier, vol. 49(C), pages 1-18.
    4. Norbert Funke & Akimi Matsuda, 2006. "Macroeconomic News and Stock Returns in the United States and Germany," German Economic Review, Verein für Socialpolitik, vol. 7(2), pages 189-210, May.
    5. Pasour, E.C., Jr., 1980. "A Critique Of Federal Agricultural Programs," Southern Journal of Agricultural Economics, Southern Agricultural Economics Association, vol. 12(01), pages 1-9, July.
    6. Chan, Kam C. & Cheng, Louis T. W. & Lung, Peter P., 2003. "Moneyness and the response of the implied volatilities to price changes: The empirical evidence from HSI options," Pacific-Basin Finance Journal, Elsevier, vol. 11(4), pages 527-553, September.
    7. Tabesh, Hamid, 1987. "Hedging price risk to soybean producers with futures and options: a case study," ISU General Staff Papers 1987010108000010306, Iowa State University, Department of Economics.
    8. Fang Liang & Lingshan Du & Zhuo Huang, 2023. "Option pricing with overnight and intraday volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(11), pages 1576-1614, November.
    9. Nikkinen, Jussi & Omran, Mohammed & Sahlstrom, Petri & Aijo, Janne, 2006. "Global stock market reactions to scheduled U.S. macroeconomic news announcements," Global Finance Journal, Elsevier, vol. 17(1), pages 92-104, September.
    10. Feil, J.-H. & Anastassiadis, F. & Mußhoff, O. & Schilling, P., 2015. "Analysing Farmers’ Use of Price Hedging Instruments: An Experimental Approach," Proceedings “Schriften der Gesellschaft für Wirtschafts- und Sozialwissenschaften des Landbaues e.V.”, German Association of Agricultural Economists (GEWISOLA), vol. 50, March.
    11. Szakmary, Andrew & Ors, Evren & Kyoung Kim, Jin & Davidson, Wallace III, 2003. "The predictive power of implied volatility: Evidence from 35 futures markets," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2151-2175, November.
    12. Onan, Mustafa & Salih, Aslihan & Yasar, Burze, 2014. "Impact of macroeconomic announcements on implied volatility slope of SPX options and VIX," Finance Research Letters, Elsevier, vol. 11(4), pages 454-462.
    13. An N. Q. Cao & Michel A. Robe, 2022. "Market uncertainty and sentiment around USDA announcements," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(2), pages 250-275, February.
    14. Richards, Timothy J. & Manfredo, Mark R., 2003. "Infrequent Shocks and Rating Revenue Insurance: A Contingent Claims Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 28(2), pages 1-19, August.
    15. Huang, Hong-Gia & Tsai, Wei-Che & Yang, J. Jimmy, 2024. "Trading activity of VIX futures and options around FOMC announcements," International Review of Financial Analysis, Elsevier, vol. 94(C).
    16. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    17. Krieger, Kevin & Mauck, Nathan & Vazquez, Joseph, 2015. "Comparing U.S. and European market volatility responses to interest rate policy announcements," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 127-136.
    18. Davidson, Wallace N. & Kim, Jin Kyoung & Ors, Evren & Szakmary, Andrew, 2001. "Using implied volatility on options to measure the relation between asset returns and variability," Journal of Banking & Finance, Elsevier, vol. 25(7), pages 1245-1269, July.
    19. Lai, Ya-Wen, 2017. "Macroeconomic factors and index option returns," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 452-477.
    20. Cremers, Martijn & Fleckenstein, Matthias & Gandhi, Priyank, 2021. "Treasury yield implied volatility and real activity," Journal of Financial Economics, Elsevier, vol. 140(2), pages 412-435.

    More about this item

    Keywords

    Marketing;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:aaea05:19271. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: AgEcon Search (email available below). General contact details of provider: https://edirc.repec.org/data/aaeaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.