| Futures contracts often contain delivery options in order to reduce the risk of market manipulation. By giving the seller alternatives about the timing, grade, and location of delivery, the options expand the deliverable supply. They may, on the other hand, distort the correlation between the futures prices and the underlying spot prices and thus contribute to basis risk.;This study develops a discrete model for valuing the timing option separately and then jointly with the location option. The values of the options implicit in the Chicago Board of Trade corn contracts are estimated for the years 1989--97. The estimated values are used to help explain basis behavior at contract maturity. Then, the option values two months before the expiration month are estimated and evaluated as a way to improve forecasts of basis changes.;Two models for valuing options are presented that rely on different assumptions about the delivery process. The first model approximates the discreteness of the three-day delivery process, while the second permits immediate delivery, consistent with the theoretical literature. The two models lead to different conclusions about early delivery for futures contracts with the timing option only. For a binomial process, early delivery is always optimal when same day delivery is permitted. This result does not hold for a trinomial process, where the optimality of early delivery is a function of interest rates and volatility. When a one-day delay is required between entering a contract and delivering, delaying delivery may yield higher payoffs for both binomial and trinomial processes. The timing option has a positive value under both assumptions.;Adding the location option increases the option values. In a complete market (trinomial process with two state variables), delaying delivery may be optimal under both assumptions for futures contracts with the joint option. The joint option is a significant factor in explaining basis variability in Toledo and Central Illinois. With convenience yield incorporated, the option values significantly explain basis behavior in all locations. The option values estimated at two months prior to expiration provide small improvements in the ability to forecast basis changes over the two-month interval. |
