Drivers of Black Sea Wheat Option Usage

Black Sea Wheat options greatly increased their footprint in 2019, especially for new crop July/Aug 19 calls and puts. In fact, options accounted for a quarter of total volumes traded in March (5,000 contracts). Black Sea Wheat options were launched in July 2018, seven months after the futures.

Chart 1 – Black Sea Wheat Futures and Options Volume

Source:  CME Group

Activity in July 19 options was preceded by a build-up in trading activity in the underlying futures that started as early as September 2018. The bulk of the July 19 options activity took place in early March, amid favourable growing weather. The spread between old and new crop held steady, as futures prices for July 19 dropped rapidly from above 210 $/MT to below 195$/MT.

The drop in prices seems to have spurred activity in the options space. It is possible that new participants entered the market because implied volatility levels made it possible for option sellers to capture more attractive option premia. Simultaneously, heightened price volatility and the July 19 futures price low may have motivated hedgers to use options to lock in new crop prices.

Chart 2 – BWF July 19 Futures Prices and Options Activity

Source:  CME Group

During two weeks of trading in early March, we saw most activity in the 190$ puts (over 1,000 contracts) as well as the 195$ calls (1,000 contracts). The 190$ puts were transacted just when the futures contracts bottomed out at around this level – this may indicate that some participants wanted to lock in a floor for their new crop price as the price outlook deteriorated, while other firms stood ready to provide prices as they wanted to capture option premiums at those depressed price levels.

Activity in the calls is reflective of capturing upside potential. Also, as the upside skew strengthened, higher strikes were quoted at more attractive implied volatility levels. The below chart shows the settlement price of the futures, superimposed with information about strike and type of options traded (calls in blue, puts in yellow). The size of each option “bubble” represents the amount transacted.

Chart 3 –July 19 Options – Traded Contracts and Futures Price

Source: CME Group. Data as of March 29, 2019

Before options traders entered the market in late January 2019, activity in the August 19 futures was subdued. A high number of options were traded in late January, just as the futures price followed July 19 downwards to prices below 195$/MT. Another surge of trading activity occurred in late March.

Chart 4 – BWF August 19 Futures Prices and Options Activity

Chart 4 – BWF August 19 Futures Prices and Options Activity

Source:  CME Group

Prior to and during the price drop, a high number of out-of-the-money calls (>1,500 options) were written at strike levels of 220$/MT. As in chart 5 below, option sellers were able to sell call options whilst still leaving a gap between current prices and the call strike level. Following the price drop, we saw over 2,000 calls exchanged at strike levels of 205$/MT.

Chart 5 – August 19 options – traded contracts and futures price

Summary

The Black Sea Wheat options market is evolving and attracting new participants. Based on CME Group’s interaction with the market, existing and new firms are seeking opportunity in Black Sea Wheat volatility versus other wheat benchmarks.

The falling price of new crop wheat may have spurred activity across the options complex as physical market players sought to optimize their exposure to the new crop.

With growing liquidity in the futures contract, participants may also be able to delta hedge their options more efficiently. As the market currently prices in a large 2019 new crop, any changes to the fundamental outlook may trigger a strong price reaction and options contracts may be able to help counteract against such changes.