Hedging price risk to soybean producers with futures and options: A case study

Soybean producers have faced considerable price risk in recent years. The large variations in soybean prices have been increasingly noticeable in the last 15 years or so as compared with the 1950s and 1960s. Harvest cash returns have been highly volatile and frequently low. Soybean producers have available a number of marketing alternatives which they can use to help reduce price risks for their product. These alternatives include futures as well as options markets for soybeans. However, less than ten percent of U.S. major-crop farmers currently employ futures and/or options contracts in the marketing of their products. This situation stems mainly from lack of enough information currently available on how the use of these contracts affects the prices received by farmers for their products. Relatively little research has been done thus far on marketing strategies for major-crop farmers. The purpose of this study is to partially remedy this situation.;Forty-two marketing strategies involving cash sales, futures market contracts, and options market contracts for soybean farmers in Northcentral Iowa were simulated over the period of 1975 through 1985. Because soybean option contracts were not traded in the U.S. before November 1984, options premiums were estimated for the 1975-84 period with a modified version of the Cox, Ross, and Rubinstein (1979) model. An attractive feature of this model is that it takes into account the effects of government price supports on options prices. The results of mean-variance and mean-semi-variance analysis (both in current and constant dollars) indicated that most of the pre-harvest routine hedging strategies, routine at-the-money puts purchasing strategies, and post-harvest selective hedging strategies based on cost of production increased the average net returns and reduced the variability of returns relative to the cash only strategy. However, post-harvest put option purchasing strategies and routine storage strategies did not perform well in comparison with the cash market.