Commodity options as an alternative to hedging live cattle

189 Pages·2016·3.16 MB·English

Iowa State University Capstones, Teses and
Retrospective Teses and Dissertations
Dissertations
1980
Commodity options as an alternative to hedging
live catle
Lowell B. Catlet
Iowa State University
Follow this and additional works at: htps://lib.dr.iastate.edu/rtd
Part of the Agricultural and Resource Economics Commons, and the Agricultural Economics
Commons
Recommended Citation
Catlet, Lowell B., "Commodity options as an alternative to hedging live catle " (1980). Retrospective Teses and Dissertations. 6713.
htps://lib.dr.iastate.edu/rtd/6713
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CATLETT, LOWELL B.
COMMODITY OPTIONS AS AN ALTERNATIVE TO HEDGING LIVE
CATTLE
Iowa State University PH.D. 1980
University
IVIicrofilms
I n t© rn at i On 3,1 300 N. Zeeb Road, Ann Arbor, MI 48106
Commodity options as an alternative
to hedging live cattle
by
Lowell B. Catlett
A Dissertation Submitted to the
Graduate Faculty in Partial Fulfillment of the
Requirements for the Degree of
DOCTOR OF PHILOSOPHY
Department: Economics
Major: Agricultural Economics
Approved:
Signature was redacted for privacy.
Signature was redacted for privacy.
he Major De rtment
Signature was redacted for privacy.
For the Graduate Coll
Iowa State University
Ames, Iowa
1980
li
TABLE OF CONTENTS
Page
CHAPTER 1. INTRODUCTION 1
Problem Situation 3
Futures options 3
Dealer and exchange options 4
'Weak* and 'strong' options 4
Fixed and variable striking prices 4
Problem Justification 5
Objectives 7
CHAPTER 2. OPTION USAGE 9
Definitions 9
Buying Calls 11
Buying Puts 13
Double Options 17
Writing Options 22
Writing calls 23
Writing puts 28
Call and Put Strategies 33
iii
CHAPTER 3. REVIEW OF LITERAIUEE 36
Commodity Futures Trading Commission 36
Option regulation 37
Pilot program 39
Stock Options 53
History of stock option usage 53
Option pricing models 57
Commodity Options 65
Option pricing models 67
Commodity Futures Hedging Strategies 71
CHAPTER 4. RESEARCH PROBLEMS 75
Futures Versus Actuals 75
Dealers Versus Exchanges 80
'Weak'Versus 'Strong' Options 83
Fixed Versus Variable Striking Prices 88
Option Markets
CHAPTER 5. HEDGING THEORY AND METHODOLOGY 94
Hedging Theory 94
Option Hedging Theory 101
Option Versus Futures Hedges 101
Objective and Hypotheses 104
Variance of prices 105
iv
Mean gross returns 105
Testable hypothesis for objective 3 107
Model, Hedging Strategies, and Data Base 107
Simulation model 108
Assumptions 109
Interest, brokerage fees, premiums. and other costs 111
Producer 112
Data base 112
Futures and Option Strategies 114
Futures strategies 114
Option strategies 116
Complete and Partial Feeding Activities 121
Details of the Model 121
Tests of significance 125
Tests of variance equality 126
Tests of gross mean equality 127
CHAPTER 6. RESULTS AND INTERPRETATIONS 131
Full Hedge Strategy 131
Non-Delivery Month Strategy 139
Delivery Months Strategy 140
$1.00 Basis Strategy 141
$1.50 Basis Strategy 141
Double Options 142
Options Comparisons 143
Naive Versus Rational Option Sub-Strategies
Futures Hedges
Partial Feeding Activity
Non-delivery month strategy
Delivery month strategy
$1.00 basis strategy
$1.50 basis strategy
Complete Versus Partial Feeding Activities
CHAPTER 7. CONCLUSIONS AND RECOMMENDATIONS
Options as Hedges
Policy Recommendations
Future Research
BIBLIOGRAPHY
1
CHAPTER 1. INTRODUCTION
Recorded history sheds very little light on option trading,
although scholars generally agree that it has existed for several
millenniums. The early Phoenician merchants, and later the Romans,
traded options on goods in their argosies (9, 79, 87). It is known
also that forms of commodity option trading existed in the early
European Pieds Poudres fairs (9, 66, 79). Holland had a thriving
option trade on tulip bulbs during 1634-1637 (2, 9, 79).
Sir Charles Leonard Woolley uncovered the Tell al Muqayyar in 1923
and found countless clay tablets describing transactions in the city of
Ur. Among the clay tablets were records of "payment in kind" for taxes
with commodities and records of "rights to buy" certain commodities
(79, p. 103). The Sumerians were trading in early forms of options as
early as 5,000 B.C. in Ur. Evidence of options, therefore, covers a
7,000 year time span.
Recent history of option trading in the United States shows
bewilderment and skepticism. Stock options had been regularly traded
prior to 1932. In that year in drawing up the Securities Act the
attitude was, "... not knowing the difference between good options
and bad options, for the matter of convenience we strike them all out"
(87, p. 10). Subsequently, however, the Securities and Exchange
Commission did allow the trading of stock-options. The success of the
stock-options is evidenced by the recent growth, popularity, and volume
of the Chicago Options Exchange (part of the Chicago Board of Trade).
2
Commodity options, on the other hand, have not fared so well.
The Commodity Exchange Act of 1922 forbids trading in options on farm
products. Subsequent rulings also outlawed options on any domestically
produced commodity regulated by the Commodity Exchange Authority. A
catch in the Commodity Exchange Act was found in 1971 regarding interna-
tional commodities. The so-called international commodities were not
under the jurisdiction of the Commodity Exchange Authority. A thriving
option business was being conducted by mid-1971 on futures contracts for
silver, silver coins, copper, platinum, coffee, cocoa, sugar, and
plywood.
The American options proved highly successful in terms of volume,
and at least one estimate placed the 1972 dollar volume of option trade
between $200 - 400 million (111). The absence of governmental
regulation, high volatility of commodity prices in the early 1970s,
high volume of trading, and several unscrupulous dealers and underwriters
provided the elements to bring the newly established market to a virtual
standstill by late 1973. Public interest was sufficiently stirred by
commodity options and consequently the 1974 amendments to the Commodity
Exchange Act [Section 4c (b)] gave power to the Commodity Futures Trading
Commission to regulate the so-called international commodities. Currently
the Commodity Futures Trading Commission has suspended all option trading
in commodities. London options are also forbidden by the recent ruling
(prior to the ban London options were the mainstay of commodity options
in the U.S.A.).