From the June 01, 2012 issue of Futures Magazine • Subscribe!

Using options to exploit anomalies in the grain complex

Volatility measures

On March 26, the options market placed July corn futures ahead of wheat, oats and soybeans in terms of predicted volatility. The curves on “Comparing July grains” (below) indicate the close fit among wheat, corn and oats, with the July soybean futures falling behind in the volatility forecast despite their faster growth trend over the past three months. As measured by the height of the call price curve as a percentage of the strike price where the futures price equals the strike price, the results are 6.68%, 6.41%, 6.02% and 4.30% for corn, wheat, oat and soybean July futures, respectively. 

With 88 days to expiration of the July calls on March 26, the options market made predictions for the upper and lower price spreads during the remaining trading days. The spreads as a percentage of the strike price nearest the underlying futures price were 26.2%, 25.8%, 23.9%, and 17.4% for corn, wheat, oats and soybeans. The price spreads are between upper and lower futures prices at expiration that would result in neither a gain nor a loss from a delta trade on March 26, buying the number of calls indicated by the slope of the options price curve for each July futures contract sold short.

The spread implies futures price variations over the next 88 days of approximately 9% to 13%, up or down from the current futures price or about half of the predicted spread in either direction.

“Calls on wheat futures” (below) shows the May, July, September and December price curves for July wheat on March 28. Separations between options price curves on “Comparing July grains” are caused by differences in options market forecasts for grain futures volatilities at the same expiration date, while the curves on “Calls on wheat futures” are spaced apart because of changes in time to expiration and will shift up or down together depending on the market’s assessment of wheat futures volatility. (One way to think about wheat futures volatility is the chance there will be a futures price variation large enough to make purchasing a put or call option potentially profitable.)

On “Calls on wheat futures,” the curves for successively longer times to expiration have the following heights above the strike price: May, 3.95%; July, 6.33%; September, 7.91%; and December, 9.85%. It is typical for the price curves to be spaced closer together at longer times to expiration and to have larger spreads as expiration nears and accelerates the erosion of shorter-term time value premiums.

In “Building forex volatility strategies” (April 2012), it is suggested that variations of call or put prices from hypothetical or theoretically correct price curves could be the basis for spread trades between adjacent strike prices. Put and call options tend to be priced by variants of the Black-Scholes option pricing model, and this practice makes it easy to spot any option that is temporarily mispriced.  

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