With the volatile price movements occurring near the close of the year 2010 and early 2011, it is interesting to see the price forecasts implied by the options market. The results of option pricing analysis are shown on "Options market forecast" (below). The analysis is based on the December 2011 expiration date for gold and silver futures on March 1, 2011. For both metals, option prices predicted by the regression equation are close to the actual market prices, showing that call price curves describe a parabola between the natural logs of option price/strike price and futures price/strike price. Heights of the call option price curves reflect the expected volatility of silver vs. gold futures, with the time premium of silver at 11.4% vs. 6.7% for gold.
It should be noted that the option pricing model is based on the market’s perception of price variability of the underlying asset. The reason that both upper and lower break-even prices are shown is that the forecast does not indicate a direction of rising or falling prices. It forecasts the price range at expiration — a forecast that the market must make on a continuous basis as a requirement for computing option price curves in which the current futures price is located at the approximate center of an estimated price range. With decreasing time to expiration, the spread between upper and lower breakeven prices will be reduced along with the associated time premiums.
The analysis shows that silver and gold futures prices are a tandem set, with silver price movements oscillating around the gold percent price changes, but with significantly greater variations. It is obvious that price changes of this magnitude are favorable to spread trading between gold and silver futures.
As shown by the high correlation between options market prices and prices predicted by the log-log regression equation, the call and put options related to every strike price have a definite place on the price curve. Completely organized markets, such as the U.S. options market, encourage spread trades and other more complex trades based on continuing predictable relationships between options and their underlying assets.