Option prices and implied volatility in the crude oil market

Vesa Soini and Sindre Lorentzen

Energy Economics, 2019, vol. 83, issue C, 515-539

Abstract: This paper studies the determinants of WTI crude oil call option prices with a special emphasis on the relationship between implied volatility and moneyness. Our first-stage regression estimates a quadratic approximation of implied volatility as a function of moneyness, while our second-stage regression investigates correlations between the estimated parameters and a list of explanatory variables. The first-stage regressions show a positive coefficient on the quadratic term, suggesting that the market exhibits ‘Implied Volatility Smile’ and hence violates the Black-Scholes predictions. The main results of our paper concern the determinants of these violations. We find that the curvature of implied volatility as a function of moneyness is: (i) positively and significantly correlated with basis and hedging pressure of the underlying crude oil futures contract (ii) positively and significantly correlated with various measures of transaction costs on the options market. We explore various explanations for these results. The paper also contains a variety of robustness checks, mostly related to the assumed functional forms.

Keywords: Implied volatility; Options; Crude oil; Hedging pressure (search for similar items in EconPapers)
JEL-codes: G1 Q4 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:83:y:2019:i:c:p:515-539

DOI: 10.1016/j.eneco.2019.07.011

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