Characterizing implied volatility functions from agricultural options markets

Abstract

We provide the first comprehensive characterization and comparison of implied volatility functions for five major agricultural options markets-corn, soybeans, soft red winter wheat, live cattle, and feeder cattle-using intraday tick data. Our results show that cattle markets exhibit a distinct leftward skew, which is puzzling and indicates that out-of-the-money traded put options are theoretically overpriced. In contrast, we find that grain market implied volatility functions display a flatter, less pronounced smile pattern. We examine market sentiment induced shortterm hedging pressures using Commodity Futures Trading Commission reports, and market uncertainty around Cattle on Feed reports, as potential causes of the cattle markets skew. However, our results show that the explanatory power of our short-term hedging pressure proxies are only helpful in isolated cases but overall cannot explain the large skews we observe in cattle markets.

The Impact of Fundamentals on Volatility Measures of Agricultural Substitutes

“…We only find evidence for hedging pressures to impact winter and spring wheat IVs. This is in line with the findings of McKenzie, Thomsen, and Adjemian (2022), who find that even though hedging pressure proxies have a significant negative impact on grain IVs, they cannot fully explain the shape of IVFs. While seasonality effects are more prominent in corn and soybean markets, maturity effects exist only in wheat markets.…”

“…Among the financial indicators, hedging pressure variables do not show any significant impact on the corn IV, consistent with the findings in McKenzie, Thomsen, and Adjemian (2022). On the other hand, CBOE's VIX has a weak positive impact on the variability of corn futures returns but a strong positive impact on IV.…”

“…In our study, we also control for these heterogeneous beliefs of market traders in the options markets by following the approach in McKenzie, Thomsen, and Adjemian (2022). These authors use short-term hedging pressure proxies, calculated using the Commodity Futures Trading Commission (CFTC) reports, to account for the possibility of market-induced pressures impacting the shape of IVFs in cattle and grain markets.…”

What do we know about the value and market impact of the US Department of Agriculture reports?

“…McKenzie et al (2022) examined the impact of USDA reports on the entire implied volatility function (IVF) of live cattle options using intraday tick data. Differently from corn, soybeans and wheat IVFs, cattle markets exhibited a distinct leftward skew, which indicates that out‐of‐the‐money put options are theoretically overpriced.…”

Risky times: Seasonality and event risk of commodities

“…Using Fourier transforms and cubic splines, they found robust patterns for option implied volatility, but the results for realized volatility remained puzzling. Other papers that analyzed option implied seasonal volatility are McKenzie et al (2022), Arismendi et al (2016), and Back et al (2013).…”