PR – Food Security: When To Buy Derivative Instruments

Commodity prices are notoriously volatile which is a major source of instability and uncertainty for commodity-dependent developing countries. Commodity price volatility affects governments, producers (farmers), traders, processors, and local financial institutions financing production inputs in these countries. There have been several attempts to deal with commodity price volatility. A number and variety of international and national institutions and programs were designed for this purpose. Most of the earlier attempts concentrated in trying to stabilize prices through the use of buffer stocks, buffer funds, government intervention in commodity markets, and international commodity agreements. These schemes have not proven satisfactory in dealing with commodity price instability. Academics and policy makers began to emphasize the distinction between programs that attempted to alter the price distribution, either domestically or internationally, with programs that deal with market uncertainty using market-based solutions. The rise in market-based commodity risk management instruments has been significant since the development of derivative instruments. The aim of this study is to determine the optimal time for African countries to buy grain by making use of call option contracts. Chicago Board of Trade contracts and contracts traded on the South African Futures Exchange were compared to determine which exchange would be appropriate, and the optimal time in which the contract should be purchased. The article starts by looking at droughts in Southern Africa, ways available to insure and/or hedge against supply risk. Thereafter, agricultural commodity market variability and volatility were analyzed to end with the determination of an optimal hedging period. The study goes on to assess the optimal timing for Tunisia to hedge their supply risk using the South African Futures Exchange as compared to the Chicago Board of Trade.

Keywords: Food security, call option, hedge, optimal time, volatility, supply risk.

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Author(s): Cutts, M., Geyser, M.


Organizations(s): University of Pretoria