The investment universe consists of 24 commodity options and their underlying futures contracts. A complete list of traded commodity options is described in Appendix A. Apply the following filters to the options universe. First, include only the standard option contracts with the same maturity months as the underlying futures contracts. Second, eliminate option prices that violate no-arbitrage boundary conditions. Third, discard options that have Black’s (1976) implied volatilities less than 1%. Last, remove options in the last week before expiration.
ASSET CLASS: futures, options | REGION: Global | FREQUENCY:
Monthly | MARKET: commodities | KEYWORD: Hedging, Commodity Option
I. STRATEGY IN A NUTSHELL
The strategy trades 24 commodity options and their underlying futures by ranking commodities weekly based on hedging pressure in options (HPO). Positions involve delta-hedged OTM calls and puts: buy calls and sell puts for commodities with high HPO, and reverse for low HPO. Portfolios are held for four weeks and rebalanced weekly.
II. ECONOMIC RATIONALE
Hedging pressure reflects imbalances in option pricing caused by producers’ and processors’ hedging activities. Buying calls and selling puts for high HPO commodities—and the reverse for low HPO—provides liquidity and captures abnormal returns driven by these pricing frictions.
III. SOURCE PAPER
Hedging Pressure and Commodity Option Prices [Click to Open PDF]
Ing-Haw Cheng, University of Toronto – Rotman School of Management; Ke Tang, Institute of Economics, School of Social Sciences, Tsinghua University; Lei Yan, Yale University
<Abstract>
A new measure of hedging pressure in commodity options markets—commercial hedgers’ net short option exposure—predicts option returns and changes in the slope of implied volatility curves. Puts are more expensive, and calls are cheaper, when values of option hedging pressure are greater. This pattern is consistent with commercial traders’ natural hedging motives. A strategy that provides liquidity to hedgers earns an average excess return of 6.4% per month before transaction costs and consideration of margin requirements. Overall, our results confirm the existence of hedging premiums, demand effects, and limits to arbitrage in commodity option markets.
IV. BACKTEST PERFORMANCE
| Annualised Return | 124.27% |
| Volatility | 92.59% |
| Beta | N/A |
| Sharpe Ratio | 1.34 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
