Costs and profit in chamomile production using weather put option

Abstract

Chamomile is very important medicinal and aromatic plant, and is used in many industries. The goal of this paper is to analyze the effect of risk elimination (effect of hedging) in production of chamomile in Serbia using weather put option based on the quantity of precipitation. The analysis is based on calculations of average costs of chamomile production per hectare, costs of agricultural mechanization, and determination of profit in chamomile production. To structure weather put option the key issue is calculation of option payoff and evaluation of risk price (fair premium) a buyer is willing to pay for risk transfer. Fair premium is determined by burn-rate method. Chamomile revenue is calculated with use of the weather derivatives and without them using stochastic simulation method. Calculations are performed by appropriate computer software (" Risk). Results have shown that use of weather put option is efficient only if production location is in the immediate vicinity of weather station and if the correlation between quantity of precipitation and chamomile yield is high.