Corn has been something of an interesting trade as of late. Prices have been fairly volatile but within a pretty defined wider range. We could roughly call this range 365-410 with reference to July prices. Looking back even farther, last year’s peak price only topped out at 417. Of course, any price can trade this year, and the weather is always the wild card, but this established range is a good starting point for discussing likely “stable condition” scenarios.
Based on the price activity of the past few months, we would expect to see a “U” type skew curve for corn. That is, a relatively similar vol within a few strikes of the at the money price. As corn as tested both extremes of the range and continues to be bound by them, any activity within this range is relatively unexciting. However, any breakout from the range would be a signal that conditions are changing, and we would expect increased volatility. That is why we suggest the U skew, stable vol while prices are stable (it can be an elevated overall vol, but still flat) and a steep skew above those breakout levels. But that is not at all what we’re seeing. In fact, we’re seeing almost the exact opposite.
(Courtesy of Quikstrike)
The skew graph above shows that there are actually 4 skews in September soybeans right now. (We’re using September as an example because there are enough DTE for it to reflect true option valuation and not simply “cheap shot” bets on futures prices)
- 330-370 – flat
- 370-420 – 1.6
- 420-450 – 1.1
- 450-550 – .6
If you were to draw a straight line through the skew from 370 to 500 you would get something that looks more like this
(Courtesy of Quikstrike)
We contended earlier that the skew should look like a U. But even with a straight line skew, some things jump out at us. Most notably is the relative overvaluation of the 420, 430, and 440 calls. The 430 strike has an implied volatility of 30.8%, but our straight line would suggest it should have, at most, a 27.6% volatility (our straight line basically assumes a skew of 1).
So the big question is, why is the market doing this? Unlike most other analysts, we’ll be honest, we don’t know! Over the years, we have seen Straight line skews, flat skews, U skews and exponential skews all forced on option pricing models to value options under relatively similar conditions. The big factor is always what the big money is doing. Funds, and other big players have a huge influence over what the options skew look like.
It’s important to remember that funds, hedgers and other large traders have motives of their own. Sometimes they are hedging risk, sometimes they are offsetting positions, sometimes they are hedging against positions in other markets. Either way, they are asserting their view of the market on the rest of us. Sometimes they are right, sometimes they are wrong. But it is always worth looking into the why, and how of what the market participants are doing. In doing so, there lie niche opportunities for the rest of us.
