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Pricing Options on Commodity Futures: The Role of Weather and Storage


  • Marin Bozic

    () (The Institute of Economics, Zagreb)


Options on agricultural futures are popular financial instruments used for agricultural price risk management and to speculate on future price movements. Poor performance of Black’s classical option pricing model has stimulated many researchers to introduce pricing models that are more consistent with observed option premiums. However, most models are motivated solely from the standpoint of the time series properties of futures prices and need for improvements in forecasting and hedging performance. In this paper I propose a novel arbitrage pricing model motivated from the economic theory of optimal storage and consistent with implications of plant physiology on the importance of weather stress. I introduce a pricing model for options on futures based on a generalized lambda distribution (GLD) that allows greater flexibility in higher moments of the expected terminal distribution of futures price. I use times and sales data for corn futures and options for the period 1995-2009 to estimate the implied skewness parameter separately for each trading day. An economic explanation is then presented for inter-year variations in implied skewness based on the theory of storage. After controlling for changes in planned acreage, I find a statistically significant negative relationship between ending stocks-to-use and implied skewness, as predicted by the theory of storage. Furthermore, intra-year dynamics of implied skewness reflect the fact that uncertainty in corn supply is resolved between late June and early October, i.e., during corn growth phases that encompass corn silking and grain maturity. Impacts of storage and weather on the distribution of terminal futures price jointly explain upward-sloping implied volatility curves.

Suggested Citation

  • Marin Bozic, 2010. "Pricing Options on Commodity Futures: The Role of Weather and Storage," Working Papers 1003, The Institute of Economics, Zagreb.
  • Handle: RePEc:iez:wpaper:1003

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    References listed on IDEAS

    1. Dubravka Jurlina Alibegovic & Zeljka Kordej De Villa, 2006. "The Challenge of Building Proper Urban Indicator System: A Proposal for Croatian Cities," ERSA conference papers ersa06p354, European Regional Science Association.
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    More about this item


    arbitrage pricing model; options on futures; generalized lambda distribution; theory of storage; skewness;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q11 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Aggregate Supply and Demand Analysis; Prices
    • Q14 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Finance

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