What are Ag Options Traders 'Smiling' About?

Our recent article on options on agricultural products marveled at the relatively low prices of at-the-money (ATM) options, especially in the face of a gathering La Niña, albeit a relatively mild one so far. As interesting as ATM options are, out-of-the-money (OTM) puts and calls are also telling their own story, arguably an even more perplexing one.

If you ask options traders, the risk for corn, wheat, soybeans and soy meal is strongly skewed to the upside.  For each of these commodities, options traders require a much higher premium on OTM calls (with strikes above the current price) than OTM puts (with strikes below the current price) (Figures 1 to 4). This suggests a greater fear for prices to move up than down.

Figure 1: Corn Implied Volatility ‘Smile’ as of February 20, 2018.

Figure 2: Hard Red Winter Wheat Implied Volatility ‘Smile’ as of February 20, 2018.

Figure 3: Soybean Implied Volatility ‘Smile’ as of February 20, 2018.

Figure 4: Soy Meal Implied Volatility ‘Smile’ as of February 20, 2018.

In some respects, fearing upside risk is not too surprising.  Crop failures are always a possibility and have the potential to send prices sharply higher.  Recently, the soy meal market has been spooked by drier and hotter-than-normal conditions in Argentina.  Also contributing to the fear of potentially higher prices is the fact that agricultural goods prices are low by recent standards and may be trading near or below the production costs of many farmers.  To find prices that were a great deal lower than current levels, one must go back to before 2007 (Figures 5 and 6). 

Figure 5: Are Depressed Prices Skewing Risks Higher?

Figure 6: Are Soybean and Soy Meal Risks Really Skewed to the Upside?

However, what is worrisome about the inexpensive downside price protection is that production and inventory are soaring for all types of crops (Figure 7-12).  If La Niña doesn’t severely damage harvests in South America, or interfere with crop planting or the growing season in North America, the high level of ending stocks and near record levels of production of corn, wheat and soybean could put downward pressure on prices.  This is particularly true if Black Sea production of corn and wheat continues to surge. If one believes that the future changes in prices for agricultural goods are normally distributed (upside and downside risks are equal), then the likelihood of a sharp drop in prices should be equal to the likelihood of strong gains in prices.

Figure 7: 2018 is Projected to have the Second Highest Soybean Production on Record.

Figure 8: 2018 Will Likely See the Highest Ever Inventories of Soybeans.

Figure 9: Corn Production May be the Second Highest Ever in 2018.

Figure 10: USDA Projects Fourth-Highest Ending Stocks on Record.

Figure 11: Record Wheat Production.

Figure 12: And Record Wheat Inventory. Is this Really Bullish?

Finally, the abundant supply is not the only downside risk.  While the global economy is in a synchronized recovery, which should underpin strong demand growth, credit conditions in China are tightening and that has the potential to slow the growth in the world’s most populous country and potentially put commodity prices and emerging market currencies under renewed downward pressure.  As such, count us as skeptical of the lopsided ‘smile’ on implied volatility charts across the agricultural goods sector and concern that upside and downside risks may be more balanced than options traders anticipate.


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

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