MRCI's Seasonal Volatility

Previous contributions to MRCI's publications by Robert P. Krause have served to remind us that the option player is at least as concerned with time as he is with direction. Options themselves have many proprietary terms and tools with which to better evaluate them. A more accurate assessment of a contemplated position can be better determined if the trader is armed with these tools. Components of option-pricing models for futures include contract price, life of the option, current market interest rate, and measured volatility of the underlying contract. The Black-Scholes model is the best known and most widely used model for option pricing. The inherent risk or return associated with a position can be better gauged with a thorough understanding of the terms these models employ.

Each futures market has its own characteristic signature of normality. Option premium levels should be evaluated with respect to current market environment (trending or cycling, high or low volatility). Variance from the normal can be attributed to external influences. These may range from the seasonal to the psychological, and a good gauge of the impact these factors are expected to exert is reflected in option premium.

Implied volatility is derived from mathematical models incorporating and evaluating these premiums. What is commonly thought of as `normal' implied volatility is different from market to market, month to month, and put to call. Knowledge of seasonal factors, participant sentiment, and implied volatility are all essential considerations to the option player. A good understanding of the implied volatility concept helps the trader in determining what strategies are best employed in those market conditions that currently exist in both the underlying futures contract and the option market itself.

The charts that follow display the average historical volatility (and one standard deviation in each direction) for various futures contracts. At any given point on this line, volatility has been found above half the time and below half the time. Historical volatility has traditionally been found between the two outside bands 68% of the time. When overlaid with current implied volatility we are able to distinguish those levels that fall outside the historical norm, creating a reference point regarding current option market prices.

Seasonal Volatility Charts

The charts on these pages show the historical seasonality of price volatility. It is quite obvious that the grain markets typically have their highest volatility in the summer months. One should be cautious in selling relatively low volatility as historically volatile time periods approach.

Much like MRCI's futures and spread seasonal charts, the daily volatility seasonal charts combine the current market in the upper portion of the chart with several current and historical series in the lower. Two represent the current market's volatility. The red series is the current implied volatility, while the purple series is the current historical volatility. The green and blue are the historical volatility's central tendency (average), and one standard deviation above and below the central tendency.

Two other views provide historical reference to a market's implied volatility. Both a Weekly and Monthly Continuation Chart round out the historical analysis. These charts provide historical perspective to implied volatility for the final (up to) twelve (12) months prior to expiration of each contract.

To reiterate, option trading profits are maximized by being able to properly identify mispriced options. Obviously, option writing is best exploited by selling overpriced options and option buying by purchasing underpriced ones. The following pages include historical central tendency charts overlaid with current levels of implied volatility. Referring to these should help the option trader to identify and exploit mispriced options, to identify historical seasonal volatility tendencies, and to better hedge himself against risk.

Volatility data provided by barchart.