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Analogy Based Valuation of Commodity Options

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  • Siddiqi, Hammad
Abstract
Typically, three types of implied volatility smiles are seen in commodity options: the reverse skew, the smile, and the forward skew. I put forward an economic explanation for all three types of implied volatility smiles based on the idea that a commodity call option is valued in analogy with its underlying futures contract, where the underlying futures price follows geometric Brownian motion. Closed form solutions for commodity calls and puts exist in the presence of transaction costs. Analogy based jump diffusion model is also developed. The smiles are steeper with jump diffusion when compared with smiles with geometric Brownian motion.

Suggested Citation

  • Siddiqi, Hammad, 2015. "Analogy Based Valuation of Commodity Options," Risk and Sustainable Management Group Working Papers 197334, University of Queensland, School of Economics.
    • Handle: RePEc:ags:uqsers:197334
    DOI: 10.22004/ag.econ.197334
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    References listed on IDEAS

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    Cited by:

    1. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," MPRA Paper 62333, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call writing," MPRA Paper 62763, University Library of Munich, Germany.

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