Category Archives: volatility

The uncertain future of natural gas

Today is the official release event for the MIT study on the Future of Natural Gas. It’s a wide ranging study examining the role of natural gas in meeting future energy demand under carbon dioxide emissions constraints, and recommending appropriate policies–both for the US government and for industry. I was a member of the study group producing the study. I’ll let the full length study speak for itself on the many different issues it addresses. I want to use this blog post to expand on one specific point which is the huge uncertainties we face in charting any path forward as manifested in the fluctuating price of natural gas.

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The elusive black swan of 2011

The term Black Swan has gained popularity of late, largely due to the enormous success of Hollywood’s recent thriller of the same name. The Black Swans we discuss in this article, however, are more unpopular, involving neither ballet, nor popcorn, nor – most importantly – any synopsis of what we are about to experience. These are rare events with dramatic consequences, and extremly difficult to predict. In this post, we will look at several key indicators of looming financial disaster to determine whether we can predict a would-be Black Swan Event.

Students rarely remember “skewness” after a Statistics course. The measure captures how asymmetric the probability distribution of a random variable is. A left skewed distribution indicates that the tail on the left side is longer than the tail on the right side; even if most outcomes are above the mean, low outcomes can be much larger than high outcomes.

After the stock market crash of October 1987, the Chicago Board of Options Exchange (CBOE) introduced a Skew Index on the S&P 500 that allows investors to gauge tail risk in the stock market, with returns lower than two standard deviations below the mean indicating high lower tail risk. The Skew is calculated from the prices of out-of-the-money put options on the S&P 500.[1] Traders pay attention to the volatility smile of options, which relates the option-implied volatility to the degree of the option’s moneyness. Out-of-the-money options tend to have higher implied volatilities than at-the-money options. As lower tail risk increases, the slope of the left part of the smile steepens, turning the smile into a grimace of apprehension at the prospect of a higher probability of extreme downward moves. Continue reading

The cloud in silver pricing

On Thursday, May 5, commodities markets fell sharply. On that day alone, the DJ-UBS index of commodities prices lost 4.7 per cent. The rout is said to have started in the market for silver, but rapidly spread to a wide range of commodities.

Silver is used for commercial purposes. Recently, however, the metal has been trading predominantly as a speculative asset. A lot of people now associate silver with the role traditionally given to gold as a store of value against the erosion of fiat money. As such, the price of silver, instead of reflecting the value of the stream of income derived from the traditional commercial uses, is driven by changing beliefs about grand macroeconomic events. This is how silver has gone up by more than 70 per cent in just three months, between the end of January and April 29.

Silver prices halted their rapid ascent with an abrupt fall of 28 per cent in the first week of May. Fundamentals can hardly explain such a violent reversal. Searching for an answer, many pointed their fingers at the Exchange, which raised margin requirements on futures positions four times for a total increase of 61 per cent since April 25. Three increases happened in just five trading days. The argument goes like this: many investors, surprised by the repeated large margin increases were unable to quickly arrange financing of the margin and were forced to sell their positions, driving the price down. This selloff may have been aggravated as other investors panicked. Some complain that the Exchange was deliberately, and unfairly, trying to push prices down. Others use the occasion to press the political case in favor of more aggressive use of margin requirements as well as position limits to stop speculators from inflating the price in the first place.

The events of the last couple of weeks in the silver market are a useful opportunity to briefly review the role of margin requirements and what is known about their impact on trading and prices. Continue reading

Swing a Vix con un tango

On February 25, Izabella Kaminska in FT Alphaville blasts the forecasting ability of the Vix futures, a CBOE futures contract that measures the volatility of the S&P 500 stock market index. Since 2009, the Vix futures has remained in contango–meaning that the far out prices exceed the near delivery future prices-and Vix futures repeatedly exaggerated their predictions of the actual volatility.

The first graph below shows the term structure of the Vix futures contracts for several trading dates in 2010 and 2011. The graph indicates that the futures curve has remained in contango.  A closer examination indicates a relationship between the level of volatility and the steepness of the curve: A higher (smaller) level of the spot/near term volatility seems associated with a less (more) pronounced contango.  The second graph shows the same relationship after normalizing the near term futures  price to 100. On July 20, 2010, the near volatility was 28.45 and the far out volatility was 33.2, a 16.7 percent higher. By January 24, 2011, when the near volatility was a much lower 16.15, the far out contract was 26.6, a whopping 64.7 percent difference.


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