Incorporating options and forecast information in producer hog marketing strategies: Conceptual and measurement issues

Both options and better information about prices have been proposed to increase the attractiveness of livestock hedging strategies. This study examines the value of incorporating both into hedging strategies for live hogs. A two-period simulation model in which a hog producer chooses a hedging strategy by maximizing expected utility of returns through buying or selling futures and options contracts is developed. The producer chooses among 2187 strategies consisting of simultaneous cash, futures, and options positions. Three alternative producer utility specifications are considered. Two include only the mean and variance of the producer's returns, while the third also incorporates skewness. For each specification, three risk preferences are examined. The analysis focuses on assessing the value of options, identifying "best" and "robust" strategies across different preference specifications, measuring the value of better information to a producer using options, and the appropriateness of the mean-variance specification for analyzing options positions.The results indicate that the value of options to a hog producer can range from zero to high. When the producer's price expectations coincide with the market's, the value of using options is zero; a non-options strategy, either a cash-only or short futures position, is best. However, as the difference between the producer's expectations of mean and volatility and the market's expectation increases, the value of using options increases. The value of information about prices ranges from less than zero to high. In general, the value of information also is directly related to the difference between the price distribution expected by the market and the true distribution.While the best strategy is quite sensitive to the producer's expectations of prices, the analysis identifies several straightforward option strategies that producers can use to provide near-optimal returns over a range of price expectations. Finally, the results indicate that even in the presence of options the mean-variance specification for producer preferences is a good approximation to more general specifications except when the producer's price expectations are considerably different from the market's.U of I OnlyETDs are only available to UIUC Users without author permissio