How do you straddle hogs and pigs? Ask the Greeks!

Abstract

Evidence of distortions is found in commodity options premiums around informational events. Option Greeks are used to uncover the nature of these distortions in terms of underlying factors. Both changes in underlying futures prices and implied volatility are mispriced.

Notes

¹ Data on closing prices for nearby live/lean hog futures contracts, closing put and call options premiums, and implied volatility were obtained from Bridge CRB. The implied volatility measure is derived from Black's option pricing model and is an average implied volatility based on premiums for the two nearest the money call options and the two nearest the money put options. Release dates for HPRs are from the USDA Agricultural Marketing Service.

² The Exchange charges half tick to liquidate an option that is deep out of the money. This is another precedent for approximating transactions costs in this manner.

³ An exhaustive discussion of the binomial model is available in most textbooks on options. The models are dynamic programs solved by backwards recursion through a lattice (tree). Computer code for the models used in this study was written in SAS IML and is available from the authors.

⁴One might conclude that the negative and significant returns for positions after the report are indicative of profits to be had by taking a position opposite that of the long straddle (i.e., a short straddle). Drawing such a conclusion from Table 1 would be inappropriate. Results (not shown) indicate no statistical evidence of persistent profitability from short straddle strategies around HPR releases. It should also be noted that the short straddle, unlike, the long straddle has unlimited downside risk.

⁵ Even under the assumption of zero transactions costs results (not shown) provide no evidence of profits from long straddle positions offset on any day other than day 0.