Hedging Pressure and Commodity Option Prices
43 Pages Posted: 1 Oct 2021
Date Written: September 29, 2021
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: Suggested Citation