DIFFERENT OPTIONS FOR PRICING OPTIONS? Whilst negative WTI prices and super contangos were hard to comprehend, the options market also faced an unusual situation, with low strike WTI put options being being bought for premiums greater than their put strike, giving put options with negative break even prices.
MARKET PREMIUMS: This Bloomberg screenshot from 27 April shows WTI June 2020 put options data, expiring 14 May and basis June WTI futures at $14.62/ bbl, with Put strikes, bids and offers, implied volatility for bids, offers and market (IVB, IVA, IVM) and Delta (sDM).
The data on this screen can be replicated using a Black Scholes model, using a zero price for the market floor, and the implied volatility data was calculated from the premium bids and offers showing in the market.
For example, the $1.50/bbl Put Strike is offered at a premium of $1.59/bbl, with an implied volatility of 1886% and a delta of -0.5%
Table 1
The data on the Bloomberg screen was rather different to the data on the CME’s screen, with the CME’s own WTI options screen of 27 April showing rather different “option greeks”:
This CME screenshot was taken basis a lower underlying June WTI futures price of $12.25/bbl, and the screen shows Calls on the left and Puts on the right, separated by Strikes in the middle in Green, showing premium Bids and Offers, Implied Vols and Deltas (triangle symbol).
The CME screen (Table 2) shows the $1.50 Put offered at a premium of $1.91/bbl, i.e. a minus $0.41/bbl breakeven price. This is based on the CME’s implied volatility of 63.68% with a delta of -22%, but these numbers don’t fit with the data for implied volatility and delta on the Bloomberg screen, or a Black Scholes model basis a floor price of $0/bbl.
In mid-April, the CME announced a different options methodology, signalling the possibility of a switch from Whaley to Bachelier models if WTI months settle below $11, and a definite switch if settlement below $8/bbl.
The Whaley model is similar to Black Scholes but incorporates dividend payments for valuation of equity options, whilst the Bachelier model is a very early option model (using normal distribution instead of log normal distribution) which helps modelling for strikes below zero and was recently applied when interest rate markets went negative in late 2019.
Source: Bloomberg
To simplify, option models calculate the probability of the current price reaching different prices in the future, largely based on price volatility and time to expiry, and then calculate the value of particular option strikes based on this expected price distribution.
Table 2
Source: CME
26 | ADMISI - The Ghost In The Machine | Q2 Edition
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