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3. 2011 Extension Risk Management Education National Conference

Crop Insurance Options are “Cheap”

G. Art Barnaby, Jr.

Summary

Farmers are likely to suffer “sticker shock” when they see their premium cost this spring. Their first reaction might be to cancel their revenue coverage and select Yield Protection (YP). The same price election will be used for YP and Revenue Protection (RP) so that both contracts will have the same yield protection. Adding the harvest price and revenue endorsements to YP will create RP that also includes price risk.

However, the price endorsements are Asian yield adjusted options. Unlike CME options these options have the following limitation:

1. Farmers can always produce their way out of a price loss in the Revenue Protection (RP) contract.
2. The RP options settle on a monthly average price not a spot market.
3. RP options have no time value and one cannot exercise the option.
4. The RP “put” option can take on negative values unless the insured also purchases the harvest price endorsement (“call”).

Rather than select YP, a better alternative is to purchase the 80% RP enterprise coverage. RP “call” will increase the coverage if prices increase but it will also eliminate the negative values on the RP-HPE “put”. One can reduce their risk protection costs, by selling CME options (write covered options) on the part of the guarantee that one does not expect to use. This will reduce the cost for revenue protection rather than changing to yield only guarantee. A case study was used to teach producers how to combine covered options with RP, SURE, ACRE and marketing.

Details

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