How to Hedge Surging Commodity Prices When Implied Volatility Explodes

Commodity prices have rocketed higher, and the rally has made it challenging to use options to hedge your exposure. Typically, you might consider using options contracts if you want to buy or sell and limit your risk.

If you thought corn or oil prices had moved too high too fast, you might consider using a put to bet on a decline in the price. One of the issues you might face if prices have raced is that the premiums charged for buying options have accelerated sharply.

One of the ways you can gauge if options are expensive or cheap is to chart at-the-money options implied volatility. Implied volatility is the market’s view of future volatility and is the component used to price call and put options.

From the implied volatility chart of the Teucrium Corn ETF (CORN), which holds Chicago Mercantile Exchange futures contracts, you can see that implied volatility has spiked to the highest levels on record for this Corn ETF.

Let’s assume you owned CORN and wanted to keep your position but did not want to purchase a put because implied volatility is so high. You can offset that cost of the put by buying a zero-cost collar. When you use this trading strategy, you purchase an out of the money put and simultaneously sell an out-of-the-money call.

Since you are buying and selling options, your exposure to high levels of implied volatility is mitigated. The deal you are making is that you are willing to give up some of your future upsides to protect yourself from a decline in the price. The zero-cost collar gets its name because the value of the purchase is offset by the call you sold.

https://www.alphaquery.com/stock/CORN/volatility-option-statistics/30-day/iv-mean