Hedging Pressure and Commodity Option Prices

43 Pages Posted: 1 Oct 2021

See all articles by Ing-Haw Cheng

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

Date Written: September 29, 2021

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.

Keywords: commodities, options, hedging pressure

JEL Classification: G12, G13

Suggested Citation

Cheng, Ing-Haw and Tang, Ke and Yan, Lei, Hedging Pressure and Commodity Option Prices (September 29, 2021). Available at SSRN: https://ssrn.com/abstract=3933070 or http://dx.doi.org/10.2139/ssrn.3933070

Ing-Haw Cheng (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://inghawcheng.github.io

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

Lei Yan

Yale University

New Haven, CT 06511
United States

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