In our previous paper, we examined whether futures markets tend to trend in the same or opposite direction of their respective CVOL options skew. Some markets, including bonds and several currency pairs, have moved in the same direction as investors’ perceptions of the most extreme potential risk. Other markets, including energy and metals, tend to do the opposite, falling when investors perceive a higher upside than downside risk, and vice versa. One exception has been the grains market, which do not show a strong tendency either way. This is not to say that their CVOL skew – the difference between the up/down volatility – isn’t of potential interest to traders.

In fact, the CVOL skew on corn, wheat and soybean complex is fascinating for a very simple reason: most of the time, CVOL on agricultural options skews upwards. Moreover, it does so despite any strong evidence that crop prices are given to more extreme upside than downside moves. A decade of data shows little or no tendency for crop prices to have more extreme upside than downside moves, suggesting a possibility of inefficient pricing in the options market.

(Can the CVOL skew be a leading indicator of prices trends in commodities, currencies and bond markets? Read our article).

When applying the standard test for skewness, one finds that since the 1970s there is little evidence of a skew in any of the products. Typically, a skew above +1 or below -1 would be considered to be strongly skewed. Skews in the range of -1 to -0.5 or between +0.5 and +1 would be considered to be mildly skewed. However, none of the grains futures have shown any strong or even mild skewness over the past 53 years.  Soybean daily futures returns have shown an extremely weak negative skew and wheat has shown an extremely weak positive skew, but nothing more. The others are a bit more mixed, but with nothing to suggest large moves one way or the other. 

Switching to weekly returns data doesn’t change the picture much – or at least not in any way that would support the idea that out-of-the-money calls should be more expensive than out-of-the-money puts. On a weekly basis, corn and soybean returns have usually skewed negative with the biggest weekly losses far exceeding the biggest weekly gains. Wheat, soybean oil and soybean meal have been more mixed. So far in the 2020s, the Russian invasion of Ukraine is the only evidence of a strong upward skew in the wheat markets. 

The data in tables 1 and 2 contrasts sharply with what we have observed in the CVOL skew over the past 15 years. Corn options CVOL has skewed positively 95.8% since 2007 (Figure 1). Wheat options CVOL has skewed positively 99.7% of the time. For the soybean complex, the percentages have been less extreme than for corn or wheat, but even so, soybean CVOL has skewed positively 66.6% of the time since 2007 while CVOL has skewed positively for soybean meal and soybean oil 85.5% and 89.7% of the time, respectively (Figures 2-5).

At times, perceptions of extreme upside risk dominating extreme downside risk may be wholly appropriate. This has been the case, for example, in the wheat market since the beginning of Russia’s invasion of Ukraine in February 2022. 

There are a number of possible explanations for the tendency in options to skew positively in the grains market. First, there is the structural explanation: on one side, there are hundreds of thousands of farmers whose main risk is falling prices. Normally, they would be the natural buyers of put options, which protect against downside moves in prices. On the other side, there are a relatively small number of very large, often very sophisticated buyers. Their main risk is extreme upside moves in prices, and they are the natural buyers of call options. It could be that the buyers, such as food processing and distribution companies, are more inclined to hedge using options than are farmers, who may be more inclined to hedge using mainly futures.

There is, however, another possible explanation. It may have to do with farmers’ inherent optimism, or their fear of missing out. It may be that many farmers hedge the risk of downside moves in grain prices by selling futures and buying call options. The short futures positions hedge against downside moves while long positions in call options allow them to participate in any extreme upside moves.

Whatever the explanation, one must wonder if there is an opportunity for a liquidity provider to come into market and act as a seller of upside protection and/or a buyer of downside protection given the lack of evidence that these markets are, in fact, susceptible to more extreme daily upside moves in prices than downside moves. This isn’t to say that an extreme upside price risk isn’t present, but just that it may be overpriced relative to extreme downside risk.