Characterizing implied volatility functions from agricultural options markets

Andrew M. McKenzie, Michael R. Thomsen and Michael Adjemian

American Journal of Agricultural Economics, 2022, vol. 104, issue 5, 1605-1624

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 short‐term 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.

Date: 2022
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https://doi.org/10.1111/ajae.12288

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