Commodity options as an alternative to hedging live cattle

Commodity options are currently illegal in the United States but the Commodity Futures Trading Commission is trying to initiate a pilot trading program. The success of a trial trading period depends very heavily on the type of option market established, trading rules and regulations, and how well options perform as a hedging mechanism. This study addresses the details of buying and granting calls, puts, and doubles while discussing the major problem areas facing the commodity option market. A simulation model is developed to create a synthetic options market for live cattle futures to test if options can be an alternative to traditional hedging;The economic viability of options as hedges is the crucial problem facing the development of an option market. Research results from simulated synthetic options market show that, under certain mechanical filters, option hedges are superior and at least as good as futures hedges in terms of gross mean returns and variance. Double options appear to be inferior to futures hedges when premium values approach 20 percent or more of the striking price;Specific policy recommendations are made based on the simulation results regarding whether a pilot program is feasible and the particular make-up of the trading program.