Trade War Trading
Comparative Pricing and Volatilities
“Agriculture calls” (below) shows the relative call positions of soybean, corn, cotton, wheat and cattle in the first week of April 2018. Wheat has the most volatility as expressed by the highest options price curve. Each price curve shows the relative volatility of the underlying futures contract. Only two elements determine the curve heights: time to the option’s expiration date and the relative volatility of the underlying futures contract. Because all of the options in this sample have the same expiration date, volatility is the only difference.
“Agriculture puts” (below) shows that wheat and cattle are the two highest in terms of volatility. These are followed by corn and cotton, and then by soybeans, which has the lowest volatility.
The five agriculture commodities maintain the same structure of volatilities in both charts. Volatility comparisons should be of interest in the pairs trades recommended above. Wheat has had greater volatility than corn in the recent past, and cattle has been more volatile than soybeans. Historically, wheat futures and wheat ETFs have ranged higher and lower than the more stable corn futures and ETF prices. Cattle futures and cattle ETFs have occasionally strayed higher or lower in price movements than soybean contracts.
The two charts, “Agriculture calls” and “Agriculture puts,” confirm that the options market recognizes the volatility differences among the five underlying futures. This is the basis for our recommended pairs trades above. The relative volatility and repeated swings of the more volatile member of a pair above and below the stable member are predictable, which should lead to profitable trades for the person who is patient enough to follow the price changes.
Now in the second week of April, the threats of increased tariffs between the United States and China had at least temporarily eased so that the turmoil in the futures and equities markets had calmed down. The advantage of knowing which commodities have the greatest volatility and how they might be traded in pairs is knowledge that could be even more valuable in the event a trade war reignites. It will increase volatility for all contracts, but if it doesn’t happen, these tendencies still provide valuable insight into the markets.
Along with U.S. farmers, we will hope for a peaceful and profitable year, but all followers of these markets and traders looking to find an edge should be prepared to trade agricultural futures and options whatever the political and economic outcome.