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ECON 339X: Agricultural Marketing

ECON 339X: Agricultural Marketing. Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911. Risk Management Tools Price Risk Futures, Options. Today’s Topic. Iowa Corn Yields. Source: USDA, NASS. Iowa Corn Prices. Source: USDA, NASS. Iowa Corn Revenues.

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ECON 339X: Agricultural Marketing

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  1. ECON 339X: Agricultural Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

  2. Risk Management Tools Price Risk Futures, Options Today’s Topic

  3. Iowa Corn Yields Source: USDA, NASS

  4. Iowa Corn Prices Source: USDA, NASS

  5. Iowa Corn Revenues Source: USDA, NASS

  6. Corn Futures Prices Corn users are worried about this Corn suppliers are worried about this Source: CME Group

  7. Crop Price Variability Price distributions for corn based on March prices for the following July futures

  8. Market tools to help manage (share) price risks Mechanisms to establish commodity trades among participants at a future time Available from commodity exchanges / futures markets Futures and Options

  9. Futures Markets A market where contracts for physical commodities are traded, the contracts set the terms of quantity, quality, and delivery • Chicago: Corn, soybeans, wheat (soft red), oats, rice • Along with the livestock complex • Kansas City: Wheat (hard red winter) • Minneapolis: Wheat (hard red spring) • Tokyo: Corn, soybeans, coffee, sugar • Has a market for Non-GMO soybeans • Other markets in Argentina, Brazil, China, and Europe

  10. Agricultural Futures Markets • Has some unique features due to the nature of the grain business • Supply comes online once (or twice) a year • So at harvest, supply spikes, then diminishes until the next harvest • Production decisions are based price forecasts • Planting decisions can be made a full year (or more) before the crop price is realized • Users provide year-round demand • Livestock feeding, biofuel production, food demand

  11. Futures Market Exchanges • Competitive markets • Open out-cry and electronic trading • Centralized pricing • Buyers and sellers are both in the market • Relevant information is conveyed through the bids and offers for the trades • Bid = the price at which a trader would buy the commodity • Offer = the price at which a trader would sell the commodity

  12. The View from the Corn Pit Source: M. Spencer Green, AP Photo

  13. What are options? An option is the right, but not the obligation, to buy or sell an item at a predetermined price within a specific time period. Options on futures are the right to buy or sell a specific futures contract. Option buyers pay a price (premium) for the rights contained in the option. Options

  14. Two types of options: Puts and Calls A put option contains the right to sell a futures contract. A call option contains the right to buy a futures contract. Puts and calls are not opposite positions in the same market. They do not offset each other. They are different markets. Option Types

  15. The Buyer pays the premium and has the right,but not theobligation,to sell a futures contract at the strike price. The Seller receives the premium and isobligatedtobuy a futures contract at the strike price if the Buyer uses their right. Put Option

  16. The Buyer pays a premium and has the right, but not theobligation,to buy a futures contract at the strike price. The Seller receives the premium butis obligatedtosell a futures contract at the strike price if the Buyer uses their right. Call Option

  17. The person wanting price protection (the buyer) pays the option premium. If damage occurs (price moves in the wrong direction), the buyer is reimbursed for damages. The seller keeps the premium, but must pay for damages. Options as Price Insurance

  18. The option buyer has unlimited upside and limited downside risk. If prices moves in their favor, the option buyer can take full advantage. If prices moves against them, the option seller compensates them. The option seller has limited upside and unlimited downside risk. The seller gets the option premium. Options as Price Insurance

  19. The option may or may not have value at the end The right to buy at $4.00 has no value if the market is below $4.00. The buyer can choose to offset, exercise, or let the option expire. The seller can only offset the option or wait for the buyer to choose. Option Issues and Choices

  20. The predetermined prices for the trade of the futures in the options They set the level of price insurance Range of strike prices determined by the futures exchange Strike Prices

  21. Determined by trading in the marketplace Different premiums For puts and calls For each contract month For each strike price Depends on five variables Strike price Price of underlying futures contract Volatility of underlying futures Time to maturity Interest rate Options Premiums

  22. In-the-money If the option expired today, it would have value Put: futures price below strike price Call: futures price above strike price At-the-money Options with strike prices nearest the future price Out-of-the-money If the option expired today, it would have no value Put: futures price above strike price Call: futures price below strike price Option References

  23. Options Premiums In-the-money Dec. 2010 Corn Futures $3.85 per bushel Out-of-the-money Source: CME Group, 3/26/10

  24. Options Premiums Out-of-the-money Dec. 2010 Corn Futures $3.85 per bushel In-the-money Source: CME Group, 3/26/10

  25. Short hedger Buy put option Floor Price = Strike Price + Basis – Premium – Commission At maturity If futures < strike, then Net Price = Floor Price If futures > strike, then Net Price = Cash – Premium – Commission Setting a Floor Price

  26. Put Option Graph Put Option Dec. 2010 Corn @ $3.90 Premium = $0.43

  27. Out-of-the-Money Put Put Option Dec. 2010 Corn @ $3.00 Premium = $0.07

  28. In-the-Money Put Put Option Dec. 2010 Corn @ $5.00 Premium = $1.26

  29. Long hedger Buy call option Ceiling Price = Strike Price + Basis + Premium + Commission At maturity If futures < strike, then Net Price = Cash + Premium + Commission If futures > strike, then Net Price = Ceiling Price Setting a Ceiling Price

  30. Call Option Graph Call Option Dec. 2010 Corn @ $3.90 Premium = $0.38

  31. Option fence Buy put and sell call Higher floor, but you now have a ceiling Put spread Buy At-the-money put and sell Out-of-the-money put Higher middle and higher prices, but no floor below Out-of-the-money strike price Combination Strategies

  32. Fence Buy Put Option Dec. 2010 Corn @ $3.40 Premium = $0.18 Sell Call Option Dec. 2010 Corn @ $4.40 Premium = $0.23

  33. Buyer Pays premium, has limited risk and unlimited potential Seller Receives premium, has limited potential and unlimited risk Buying puts Establish minimum prices Buying calls Establish maximum prices Summary on Options

  34. Class web site:http://www.econ.iastate.edu/classes/econ339/hart-lawrence/

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