Practical Applications of Information Leakage in Energy Derivatives around News Announcements

Abstract

In Information Leakage in Energy Derivatives around News Announcements, in the Summer 2020 issue of The Journal of Derivatives, authors Marc Bohmann and Vinay Patel (both of the University of Technology Sydney) investigate information leakage in commodity option markets, by taking a close look at abnormal changes in implied volatility spreads and skew that precede price-sensitive news releases. The growth of electronic trading platforms has made it easier to trade commodities, leading to an increase in futures and associated option contracts. These options in turn serve as a venue for information leakage.

Focusing on crude oil and natural gas futures, the most highly traded markets on the Chicago Mercantile Exchange (CME), the authors examine the implied volatility (IV) spread and skew. They show an increase in crude oil markets’ IV spread within the five days prior to positive and market-significant news releases, and in their IV skew within the days preceding negative news releases. They also find a statistically significant relationship between these abnormal pre-announcement IV measures and abnormal returns on the date of the official announcement. They report similar results in natural gas markets. These findings are relevant to regulators, investors, and firms in these energy markets, for example, in evaluating whether financial markets work properly.

TOPIC: Options