Convenience yield and the theory of storage: applying an option-based approach

Abstract

We propose that an options-based approach is a superior alternative to the traditional cost-of-carry method to model both the behaviour of convenience yields and the commodity price responses to changes in inventory levels. This approach is shown to be more robust and avoids the simplifying assumptions embedded in cost-of-carry valuation which fully accounts for the non-negativity constraint on inventory. Unlike the cost-of-carry approach, the options-based approach does not treat the convenience yield as an exogenous factor. This offers a more natural measure of implied convenience yields in commodity trading strategies. We test the relationship between convenience yields and inventory levels for a number of liquidly traded base metals using both methods. Our results show that the relationship between convenience yields and inventory levels is strongly defined under the options-based approach in line with market beliefs. This result is consistent with other studies that have used the optionsbased approach in other nonmetals commodity markets.

Market Structure, Inventories and Oil Prices: An Empirical Analysis.

“…The respective regressions follow the work done by Kucher and Kurov (2014), Omura and West (2015) and Fattouh (2009) and are represented as:…”

“…A number of studies have shown that a optionsbased approach to storage valuation models is superior to traditional methods that rely on simple calculations or estimates of the cost of carry, basis and convenience yield (Omura and West 2015). It is important to note that these studies focus exclusively on calendar-spread options, which are positions established by selling a call (i.e., the right to buy in the future) on a specific volume of an asset, at a given price, and buying a call on the same amount further in the future, at the same price.…”

Crowding out of private stocks by public stocks

“…More recent studies focused on the effects of private versus public stocks on food price volatility (Chavas and Li 2017), on the responses of commodity price to changes in stock levels (Omura and West 2014), and on the transmission and volatility of commodity prices (Bakucs et al 2012;Hassouneh et al 2017). None of these directly estimated the crowding out of private stocks by public stocks.…”

Antipodean agricultural and resource economics at 60: risk and uncertainty

“…As stabilisation fell out of favour, attention turned to the use of futures markets for producer hedging (Gruen ; Goss ; Bond et al . ; Fraser ; Simmons and Rambaldi ) and to the use of private storage to manage uncertainty (Omura and West ).…”