Implied volatility forecasts in the grains complex

Abstract

This article finds that the implied volatilities of corn, soybean, and wheat futures options 4 weeks before option expiration have significant predictive power for the underlying futures contract return volatilities through option expiration from January 1988 through September 1999. These implied volatilities also encompass the information in out-of-sample seasonal Glosten, Jagannathan, and Runkle (GJR; 1993) volatility forecasts. Evidence also demonstrates that when corn-implied volatility rises relative to out-of-sample seasonal GJR volatility forecasts, implied volatility substantially overpredicts realized volatility. However, simulations of trading rules that involve selling corn option straddles when corn-implied volatility is high relative to out-of-sample GJR volatility forecasts indicate that none of the trading rules would have been significantly profitable. This finding suggests that these options are not necessarily overpriced. Canina and Figlewski (1993) point out that implied volatility should reflect the market's assessment of realized volatility through option expiration and not necessarily over the following week. In each of their subsamples, implied volatility fails the unbiasedness tests, and in only 6 of 32 subsamples are the coefficients on implied volatility significantly greater than zero at the 5% level. These markets collectively are referred to as the grains markets for expositional ease, even though soybeans are an oilseed rather than a grain. Wilson and Fung (1990) examine the forecasting power of implied volatilities over the first 2 years of grains option trading from 1985-1986 and find mixed results. Christensen and Prabhala (1998) argue that one of the reasons that S&P 100 index implied volatility has predictive power from 1983-1995 is that the signal-to-noise ratio of implied volatility rose after the stock market crash because realized volatility rose sharply relative to implied volatility.

How do you straddle hogs and pigs? Ask the Greeks!

“…Hauser and Liu (1992) found that in general arbitrage opportunities using delta-hedged portfolios containing the theoretically mispriced options did not exist. In a similar vein Simon (2002) found insignificant profits from short-straddle positions implemented using theoretically overpriced call and put options.…”

“…The findings of these studies are consistent with conclusions from research on stock options in that they find little evidence of inefficiency. Hauser and Liu (1992) evaluated live cattle futures options efficiency over the period November 1984 to September 1987, while Simon's (2002) more recent study addressed the issue of corn futures options efficiency for the January 1988 through September 1999 period. Both studies identified mispriced options by comparing various volatility forecasts with Black model generated implied volatility measures.…”

“…The long straddle is a trading strategy that involves the simultaneous purchase of an equal number of put and call options with the same strike price. Straddles have been used in several previous studies to test for options market efficiency (Noh et al, 1994;Simon, 2002;Chen and Leung, 2003;Chong, 2004). In particular, see Chen and Leung (2003) for a review of literature involving straddle strategies.…”

“…Recent research with respect to foreign currency options indicate potential inefficiencies, depending upon transaction cost assumptions (Chen and Leung, 2003;Chong, 2004). Hauser and Liu (1992) and Simon (2002) used such an option valuation model approach to examine the efficiency of options markets for futures on agricultural commodities. The findings of these studies are consistent with conclusions from research on stock options in that they find little evidence of inefficiency.…”

The implied volatility bias and option smile: is there a simple explanation?

“…Most studies have shown that the implied volatility is a biased estimator of the future volatility (for example, Edey and Elliott (1992), Day and Lewis (1992), Lamoureux and Lastrapes (1993), Jorion (1995), Fleming (1998) and Simon (2002)). However, as described in Section 2.2, with the existing methodology, most research can only conclude whether the implied volatility is a biased estimator of the future volatility or whether the implied volatility is more or less volatile than the future volatility.…”