Impact Of Volatility On Crude Oil Prices In Arbitrage

IMPACT OF VOLATILITY IN CRUDE

Need of the study Recent volatility Effect on :arbitrage and basis

Objective The sole objective to develop a relationship

amongst basis, arbitrage and volatility.

Hypothesis: We assume that arbitrage, basis and volatility

are interrelated to each other

Contango = futures price > spot price. Backwardation = futures price < spot price.

The level and the sign of basis (i.e.

backwardation or contango) is referred to as a signal of the shortage or surplus of the physical commodity in the market. as the futures contract approaches its maturity date, the basis gets smaller, since the costs of storage are “no longer a factor” . At the time of maturity, basis diminishes to zero because spot and futures prices converge. If these price relationships do not hold, there are possible arbitrage opportunities in the market.

Spot future parity For spot and futures prices to be related, spot-

future parity should exist, which is the essence of the law of one price in futures markets. Spotfutures parity implies that stable arbitrage opportunities based on the spot-futures relationship are not possible.

an equality condition that should in theory

hold, or opportunities for arbitrage exist. Spotfuture parity is an appliance of the law of one price.

We expect that the spot price of an asset

converges to that of the futures price as the delivery date of the contract approaches , otherwise an arbitrage opportunity exists.

ARBITRAGE Attempting to profit by exploiting price

differences of identical or similar financial instruments on different markets or in different forms. The ideal version is riskless arbitrage  

Correlation between

A positive corelationship as high as 99% Arbitrage strategy

The exact nature of this relationship will

depend : on the nature of the commodity (i.e. storable and non-storable) its relative importance in the world economy seasonal factors market expectations

If the futures price stays above the spot price,

we can buy the asset now and short a futures contract(i.e. agree to sell the asset later at the future price). If the futures price stays below the spot price, anyone who wants the asset should go long on a futures contract and accept delivery instead of paying the spot price. This convergence means the spot price may go up(down), the futures price may go down (up), or both

Granger Causality Model To test this Causality we will use the Granger

Causality Model to prove the direction of influence. The Granger Causality test assumes that the information relevant to the prediction of the respective variables is contained solely in the time series data of these variables.

Result: Basis effects volatility

(whether positively/negatively)

. Corelationship between basis and volatility.

A positive corelationshipas high as 99.68%

Conclusion Basis volatility and arbitrage move in sync The hypothesis holds true