Commodity market volatility set to rise

Implied volatilities (vol) for commodities are low by historical standards.

Sure, traders have to pay relatively more for the vol element of precious metal options. But as Bank of America Merrill Lynch points out, three-month at the money (ATM) implied vols for zinc and lead are near their cheapest since January 2005.

Will vols fall further? BoAML thinks a turn in the monetary policy cycle means they are more likely to rise.

"Our analysis suggests that, just as Fed easing tends to drive commodity vols lower, higher interest rates tend to push up volatility."

In particular, the bank thinks long-dated crude oil vol is looking cheap.

WTI crude's rolling two-year ATM vol was near 30 per cent two summers ago, but is now about 18 per cent, a level BoAML describes as "extremely low" relative to recent historical patterns.

Oil vols should move up in the medium term not just because of the rising real Fed rates correlation, but also because it "looks attractive relative to other commodities such as gold" and is "appealing in the face of growing uncertainty around shale-driven energy fundamentals".

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