The Value of Deregulating Over-The-Counter Options

Hedgers located far from organized commodity exchanges suffer the mismatch between their local prices and exchange prices. Futures and options traded on the exchange may still be valuable to distant hedgers but only to the extent that basis risk is small. Forward contracting allows hedgers to manage risk using a local delivery price, but the CFTC has long banned the sale off-exchange options, limiting the opportunities available to hedgers. Recently, Agricultural Trade Options (ATOs) have been introduced as over-the-counter option products designed specifically for hedgers. To date, ATOs have found little interest from potential sellers, but the potential demand for these options may be substantial. This paper describes and quantifies the demand for corn ATOs by dairy farms in Southeastern Pennsylvania and estimates the value these farms might place on options contracts offered locally.