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Seasonality and the Valuation of Commodity Options

Abstract: Price movements in many commodity markets exhibit significant seasonal patterns. In this paper, we study the effects of seasonal volatility on models' option pricing performance. In terms of options pricing, a deterministic seasonal component at the price level can be neglected. In contrast, this is not true for the seasonal pattern observed in the volatility of the commodity price. Analyzing an extensive sample of soybean and heating oil options, we find that seasonality in volatility is an important aspect to consider when valuing these contracts. The inclusion of an appropriate seasonality adjustment significantly reduces pricing errors and yields more improvement in valuation accuracy than increasing the number of stochastic factors.

Published on 2nd September 2011
Authors Janis Back, Marcel Prokopczuk, Markus Rudolf
Series Reference 2010-08