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Valuing the quality option in agricultural commodity futures: a Monte Carlo simulation based approach

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  • Sanjay Mansabdar
  • Hussain C Yaganti

Abstract

Agricultural commodity futures are often settled by delivery. Quality options that allow the futures short to deliver one of several underlying assets are commonly used in such contracts to prevent manipulation. Inclusion of these options reduces the price of the futures contract and leads to degraded contract hedging performance. Valuation of these options is a first step in assessing the impact of the quality options embedded into a futures contract. This paper demonstrates a Monte Carlo simulation based approach to estimate the value of a quality option. In order to improve simulation efficiency, the technique of antithetic variables is used. This approach can help in the assessment of the impact of embedded quality options.

Suggested Citation

  • Sanjay Mansabdar & Hussain C Yaganti, 2020. "Valuing the quality option in agricultural commodity futures: a Monte Carlo simulation based approach," Papers 2006.11222, arXiv.org.
    • Handle: RePEc:arx:papers:2006.11222
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    References listed on IDEAS

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    1. Stulz, ReneM., 1982. "Options on the minimum or the maximum of two risky assets : Analysis and applications," Journal of Financial Economics, Elsevier, vol. 10(2), pages 161-185, July.
    2. Gay, Gerald D. & Manaster, Steven, 1984. "The quality option implicit in futures contracts," Journal of Financial Economics, Elsevier, vol. 13(3), pages 353-370, September.
    3. Jana Hranaiova & Robert A. Jarrow & William G. Tomek, 2005. "Estimating The Value Of Delivery Options In Futures Contracts," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 28(3), pages 363-383, September.
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    5. repec:bla:jfinan:v:44:y:1989:i:1:p:101-13 is not listed on IDEAS
    6. Don M. Chance & Michael L. Hemler, 1993. "The impact of delivery options on futures prices: A survey," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(2), pages 127-155, April.
    7. Charles E. Clark, 1961. "The Greatest of a Finite Set of Random Variables," Operations Research, INFORMS, vol. 9(2), pages 145-162, April.
    8. Boyle, Phelim P. & Tse, Y. K., 1990. "An Algorithm for Computing Values of Options on the Maximum or Minimum of Several Assets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(2), pages 215-227, June.
    9. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
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    Cited by:

    1. Fernandes, Vitor M. & Kunda, Eugene L. & Robe, Michel A., 2022. "Corn Futures Deliveries: Why? When? So What?," 2022 Annual Meeting, July 31-August 2, Anaheim, California 322061, Agricultural and Applied Economics Association.

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