Commodities vs. FinancialsBy: +Morris Puma
San Jose Options, Inc. is one of the leading innovators in the options teaching industry. Lately, they have been doing case studies on Commodity trades and the Financials to understand the similarities and differences between the different products when used with option spreads. The results of their studies over the market crash of 2011 have been quite eye-opening.
In using the same strategy over the crash of August 2011 on the RUT and Corn, the studies showed a pronounced increase in the IV which follows the RUT, called the RVX, when compared to the IV on the month of Corn in which they traded. The spread using RUT resulted in a draw-down of 3% while the same trade on Corn made a profit of 5%. The reason for the difference can be explained by the behavior of both price direction and the movement of implied volatility.
The RVX, which tracks the IV of the RUT, increase from 21% to 55% during the study. This represents an increase in IV of about 150%. The IV of Corn during this period rose from 25% to 34% for a change of 36%. Another aspect of the study included the price movements. Over this period of time the RUT dropped from 858 to 650 for a total of 208 points. This equates to a 24% drop in price. Corn on the other hand, rose from 616 to 689 during this period for a total move of 12%.
In summary, the RUT dropped 24% and the IV rose 150%. Corn rose 12% and its IV rose 35%. From this study we can conclude that the IV in the RUT moved much faster in relation to the price move when compared to the rate IV changed to the price change in Corn. So even though Commodities may have a reputation for being so volatile, the Financials may give the illusion that they are more stable, but when it comes to option trading, the options on Financials may be much more volatile than options on Commodities.
Obviously, this is only one case study. However, San Jose Options, Inc. has also been doing studies on Soy Beans and Wheat and they have seen a similar characteristic to the behavior of price to IV.
Since the IV changes are more pronounced in the study of the RUT, one can conclude that using options on the RUT over the recent crash would have proven to be much more volatile and difficult to manage when compared to the same trade on Corn. In fact, the RUT trade lost money while the Corn trade made money. Although Corn moved half as much as the RUT over this testing period, the IV on Corn only moved one-fourth as much. This would indicate that the Financial trade was impacted twice as much by the rise in IV as the Corn trade.
This is a very interesting study because in order to achieve a higher success rate with our option trades, we are always looking for ways to eliminate the effects of volatility. This study would indicate that trading Corn and other Commodities may be less volatile than trading the Financials such as the RUT, SPX and NDX. San Jose Options, Inc. will be conducting more similar studies on the topic. Until then, good luck with your trading, and I hope you learned something new from this article!