Effect of Derivative Trading on Commodity Prices of Sorghum Smallholder Farmers in Kitui County, Kenya

Abstract

Commodity market failure and inefficiency has caused traders to make losses at the expense of cartels and brokers who profit from these market inefficiencies. As such derivative trading is an important tool for risk management by investors in different sectors and thus sorghum farmers can trade in derivative tools.This research pursued to examine the relations between derivative trading and the commodity prices of sorghum in Kitui County, Kenya. It adopted a descriptive design of the study in which secondary data was used from reports of EAB contracted farmers, NAFIS, KNBS, KCEB,KALRO and Ministry of Agriculture, Kitui County. Data was analyzed using SPPS and the descriptive statistics (mean, medium, maximum, minimum, standard deviation and frequencies presented in forms of tables and graphs). ANOVA test was done and explanation given in prose. The findings from this study revealed the presence of an important statistical variance between the mean of spot market prices and contracted prices. This means that farmers in Kitui County who engage in forward contracts with EAB in the long run enjoy higher prices for their commodities compared to those selling on the spot market. This was as a result of rather stable prices for the commodity from the contractual agreement with EAB for commodities supplied at a given date at an agreed price. Since the derivative trading is an important tool of risk management by investors in different sectors, commodity derivative could be used in hedging to reduce potential losses by investors in their commodity market. Moreover, commodity prices are characterized by high volatility of commodity prices which makes commodity derivative trading to be an important instrument for investors to manage their risk while enjoying a given return on individual ventures.