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Smile Modeling In Commodity Markets

Author

Listed:
  • EMANUELE NASTASI

    (Exprivia, Via dei Valtorta 43, 20127 Milan, Italy)

  • ANDREA PALLAVICINI

    (Department of Mathematics, Imperial College London, South Kensington Campus London SW7 2AZ, UK)

  • GIULIO SARTORELLI

    (Financial Engineering, Banca IMI, Largo Mattioli 3, 20121 Milan, Italy)

Abstract

We present a stochastic local volatility model for derivative contracts on commodity futures able to describe forward curve and smile dynamics with a fast calibration to liquid market quotes. A parsimonious parametrization is introduced to deal with the limited number of options quoted in the market. Cleared commodity markets for futures and options are analyzed to include in the pricing framework-specific trading clauses and margining procedures. Numerical examples for calibration and pricing are provided for different commodity products.

Suggested Citation

  • Emanuele Nastasi & Andrea Pallavicini & Giulio Sartorelli, 2020. "Smile Modeling In Commodity Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(03), pages 1-28, May.
    • Handle: RePEc:wsi:ijtafx:v:23:y:2020:i:03:n:s0219024920500193
    DOI: 10.1142/S0219024920500193
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    References listed on IDEAS

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    1. Griselda Deelstra & Gr�gory Ray�e, 2013. "Local Volatility Pricing Models for Long-Dated FX Derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 20(4), pages 380-402, September.
    2. Amel Bentata & Rama Cont, 2015. "Forward equations for option prices in semimartingale models," Finance and Stochastics, Springer, vol. 19(3), pages 617-651, July.
    3. Roger W. Lee, 2004. "The Moment Formula For Implied Volatility At Extreme Strikes," Mathematical Finance, Wiley Blackwell, vol. 14(3), pages 469-480, July.
    4. Gabriel Drimus & Walter Farkas, 2013. "Local volatility of volatility for the VIX market," Review of Derivatives Research, Springer, vol. 16(3), pages 267-293, October.
    5. K. F. Pilz & E. Schlögl, 2013. "A hybrid commodity and interest rate market model," Quantitative Finance, Taylor & Francis Journals, vol. 13(4), pages 543-560, March.
    6. Nicola Moreni & Andrea Pallavicini, 2017. "Derivative Pricing With Collateralization And Fx Market Dislocations," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(06), pages 1-27, September.
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    Cited by:

    1. Piccirilli, Marco & Schmeck, Maren Diane & Vargiolu, Tiziano, 2021. "Capturing the power options smile by an additive two-factor model for overlapping futures prices," Energy Economics, Elsevier, vol. 95(C).
    2. Martino Grasselli & Andrea Mazzoran & Andrea Pallavicini, 2020. "A general framework for a joint calibration of VIX and VXX options," Papers 2012.08353, arXiv.org, revised Jun 2021.
    3. Orcan Ogetbil & Bernhard Hientzsch, 2022. "A Flexible Commodity Skew Model with Maturity Effects," Papers 2212.07972, arXiv.org.

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