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Delivery Options In Futures Contracts And Basis Behavior At Contract Maturity

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  • Hranaiova, Jana
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    Abstract

    This paper estimates values of the delivery options implicit in the CBOT corn futures contract. Joint values of the timing and location options are estimated for the years 1989-97. By interacting the effects of the two delivery options, a potentially more accurate estimates are obtained. Two models are presented that rely on different assumptions about the institutional setup of the delivery process. The first model approximates the discreteness of the three day delivery process, while the second model relies on an assumption of immediate delivery that is consistent with the existing literature on pricing options. Individual hedgers can use these models to help them make delivery decisions. When all the costs of delivery are incorporated, true value of the delivery options can be obtained analytically. This can then be used to determine possible mispricing in the market as well as optimality of delivering early or delaying delivery. The estimated option values are used to explain the variability of bases in the deliverable locations. This application is useful for the exchange in evaluating hedging performance of futures contracts with respect to the delivery options embedded in them.

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    File URL: http://purl.umn.edu/18936
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    Bibliographic Info

    Paper provided by NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management in its series 2000 Conference, April 17-18 2000, Chicago, Illinois with number 18936.

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    Date of creation: 2000
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    Handle: RePEc:ags:ncrtci:18936

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    Web page: http://www.agebb.missouri.edu/ncrext/ncr134/

    Related research

    Keywords: delivery options; joint timing-location option; basis convergence; Marketing;

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    1. Johnson, Herb, 1987. "Options on the Maximum or the Minimum of Several Assets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 277-283, September.
    2. Boyle, Phelim P, 1989. " The Quality Option and Timing Option in Futures Contracts," Journal of Finance, American Finance Association, vol. 44(1), pages 101-13, March.
    3. Frank Milne & Dilip Madan & Hersh Shefrin, 1990. "The Multinomial Option Pricing Model and Its Brownian and Poisson Limits," Working Papers 1162, Queen's University, Department of Economics.
    4. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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