The Complex World of Volatility: Part 2

In Part 1, we discussed the different types of volatility, as well as what is typical implied volatility for certain commodities. An important point to reiterate as we progress in this all-important topic is that, generally speaking, rising volatility helps the commodity sector while declining volatility helps the equities sector.

Ψ My sense since the Financial Crisis & since the beginning of the “World of Quantitative Easing”, this single feature in volatility has even more significance. In other words, given the central banks’ policies since the Financial Crisis, and given the amazingly large increase in pure Quantitative (computer-driven/algorithmic) trading, I am of the strong view that low volatility has almost equated to deflationary pressure, and that this has been a major limiting factor as to why investor rotation of their money back into the commodity sector has taken so long. If I’m correct in this analysis, greater inflationary pressure should bring with it a near-simultaneous high in equities and low in major commodity indices.

But For Now, Let’s Take a Look At Some of the Major Features Which Compliment Option Volatility Analysis

We have some matrixes and charts to look at below: 

Chart 1 = Soybean Options Matrix Showing Implied Volatility by Strike Price

Chart 2 = Soybean Options Matrix Showing Delta by Strike Price

Chart 3 = Soybean Options Matrix Showing Net Change of Options Strike by Strike Price

Chart 4 = A graph of a March $10 Soybean Put, Including a Stochastic Oscillator at the Bottom and a 40-day Moving Average.

I have chosen to post all 4 of these together intentionally so that you, as the reader, immediately understand that all of these matrixes work hand-in-hand–along with the flat price of soybean futures–in helping to determine the price of an option.

Ψ  In other words, Implied Volatility, Delta, the underlying futures trend, and the actual option technicals are the 4 most important elements of options analysis before entering into an options contract.

For today’s post, we’ll concentrate on the March $10 Soybean Put, since I charted that on Chart 4; we’ll look at each individual element of this option to see if we can deduce whether these elements help us in deciding whether to buy, sell, or leave alone the March $10 Soybean Put.

Underlying Futures

March Soybean Futures closed today at around $10.42, so a March $10 Soybean Put is over 40 cents/bu. out-of-the-money; if March Soybean Futures were $9.60, the $10 Put would be 40 cents in-the-money. Thus, at $10 March Soybean Futures, the $10 Put is at-the-money. Because this put is out-of-the-money, it is more likely for it to expire worthless. That doesn’t mean that it will, but you need to recognize that the 16 1/2 cents/bu. of premium (plus commissions and fees) has little likelihood of holding-up; the premium is more likely to erode to where the option is worthless. This is where Delta comes in in a big way, as a gauge for you at this point.

Currently in the Soybean Futures, I would be in-favor of potentially buying this put because I am worried about prices going lower: recall, a bought put is the right but not the obligation to go short futures, and the buyer pays the premium for this right, while the seller of the put receives the premium but has the risk of being assigned (similar to a short futures position). For my purposes of analysis, I am concerned that, because US ending stocks of soybeans are double what they were a year ago, it makes less sense for the price of March Soybean Futures to be around $1.50/bu. higher than year-ago levels; this is especially an issue if the South American crop is expected to receive beneficial rains…as it is currently expected to receive in the marketplace.

Implied Volatility

Recall from earlier analysis that low implied volatility usually favors the option buyer, while high implied volatility favors the seller; implied volatility on options is like the flat price in futures–buy low/sell high. Thus, when we look at the March $10 Soybean Put, we see that the current Implied Volatility (IV) = .1837, or 18.37%…very low for implied soybean volatility in my view. This makes me think more highly of my initial view that it would be better to buy a put rather than sell a call…because both are taking a short position in the market. Notice that if we look at the March $10 Soybean Call, the IV = 21.77%–still low, but not as favorable as the put.


Recall in the commentary at the beginning that I was speaking about the option premium and the fact that since the March $10 Put is 40 cents out-of-the-money, it has a lower likelihood of holding its 16 1/2 cents of premium. But can we estimate how likely this option is to expire worthless–in the market’s eyes at this precise moment? YES! This is what the Delta helps us with: the Delta on the option, in this case .2941 can be read as 29.41% likelihood the market sees this option expiring in-the-money. This is a rule-of-thumb that I have found very useful when utilizing options. The Delta also tells the prospective buyer or seller, by default, that this is also the percentage likelihood the current market expects this option to expire in-the-money…to where an option buyer can reclaim at least some of his premium spent.

The Delta also serves another valuable purpose: it gives us an idea of how sensitive the option is to the March Futures: in other words, the March $10 Put has a Delta of 29.41%; this would suggest that, all things being equal, if the March Soybean Futures itself moves 10 cents/bu., the put should gain or lose 29.41% of this, or roughly 2.9 cents/bu.

It is critical to realize also that as the price of the Underlying Futures of March Soybeans moves, the Delta automatically changes:  in the case of our March $10 Put, the higher the futures moves, the further it gets from our strike price, and the Delta falls. The opposite is true, so that, as we said at the beginning of this section, once March Soybean Futures drop below $10/bu., the March $10 Put becomes an in-the-money option. At $10 March Futures, the put is an at-the-money option; and all at-the-money options have a .5 Delta–meaning they have a 50/50 chance of going expiring in-the-money…at that given time.

Options Technical Analysis

Taking a look at the March $10 Soybean Put Chart, we see that it is currently at its lowest price level since its contract low earlier this month. In addition, the price since November suggests a head-and-shoulders bottom could be forming. Adding to this is the fact that the Stochastic Oscillator at the bottom of this chart is very low and starting to crossover, which suggests a “buy” signal is forming; this occurs when the green line goes above the purple line, like we are currently seeing in the chart above. Fourth, we see that the price of the option is very far away from its 40-day Moving Avg. in terms of distance; very often in my experience, when prices drift to the extreme distance from a major moving average, it can be a good early indicator that the current trend may be ending.

So, What Is A Sound Conclusion After Looking At All This Data?

If I am concerned about lower prices in the futures market for producer-hedging clients due to shifting weather fundamentals, the bought put is likely going to be better protection than the sold call. But the $10 March Put seems to far away from the market: it may be wise to spend another 8 cents/bu. or so and increase my strike price to a $10.20 March Put. It is only 20 cents out-of-the-money, it too has an IV under 19%, and it’s Delta is 37.84%…that’s 9% more likelihood of the option expiring in-the-money, so it makes sense to spend the extra premium.

That’s all for today. We’ll pick-up some more options analysis very soon–we’ll dig deeper into some of today’s post that I skimmed over. But I wanted the reader to get an idea of the macro-big picture of potentially selecting options.

I HAVE TO SAY AT THIS POINT, THIS IS NOT A RECOMMENDATION–THIS BLOG IS FOR EDUCTION ONLY. IF YOU HAVE A SINCERE INTEREST IN WORKING ON IMPROVING YOUR OPTIONS TRADING, CALL ME TO OPEN AN ACCOUNT. And do yourself a favor and skim over the earlier blogs–I bet they will make a lot more sense to you after reading this one. Good luck and thanks for reading!                  END