Hedging Pressure Predicts Commodity Option Returns
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Hedging Pressure and Commodity Option Prices
Ing-Haw Cheng; Ke Tang; Lei Yan
- CAUniversity of Toronto
- ?University of Toronto - Rotman School of Management
- Tsinghua University
- ?Institute of Economics, School of Social Sciences, Tsinghua University
- Yale University
Strategy in a nutshell
The strategy trades 24 commodity options and their underlying futures by ranking commodities weekly based on hedging pressure in options (HPO). Positions involve delta-hedged OTM calls and puts: buy calls and sell puts for commodities with high HPO, and reverse for low HPO. Portfolios are held for four weeks and rebalanced weekly.
Economic rationale
Hedging pressure reflects imbalances in option pricing caused by producers’ and processors’ hedging activities. Buying calls and selling puts for high HPO commodities—and the reverse for low HPO—provides liquidity and captures abnormal returns driven by these pricing frictions.
Backtest performance
Annualised return124.27%
Volatility92.59%
Sharpe ratio1.34