ERIK NORLAND, SENIOR ECONOMIST AND EXECUTIVE DIRECTOR … · El Nino La Nina Neither Annuali z ed...

1

El Niño, La Niña, Volatility and Options

18 NOVEMBER 2015 ERIK NORLAND, SENIOR ECONOMIST AND EXECUTIVE DIRECTORCME GROUP

The current El Niño weather phenomenon could be among the strongest on record and is likely to reach peak intensity between November and January. Then, it rapidly diminishes. The impact on crops and their prices, however, could last a lot longer. Our previous article (El Niño: Corn Cares; Cows & Pigs Care; You Should Care, Too) shows that El Niños can raise crop prices, and their impact on agricultural markets can last one to two years after they started forming along the equator in the Pacific Ocean.

In this paper we explore the relationship between El Niño, its counterpart, La Niña, and the volatility of prices for agricultural goods.

El Niño is a macro-scale weather anomaly that occurs when sea surface temperatures become unusually warmer-than-normal across the central and east-central Equatorial Pacific Ocean. Warmer waters tend to have more evaporation. Where the extra precipitation comes down depends on the direction the winds blow. And El Niño shifts wind patterns, too. The warmer-than-usual air over the equator in the Pacific Ocean leads to rising air currents, which can exert a southerly pull on storm tracks in North America.

Strong El Niños, like the current episode as well as the 1972-73 and the 1997-98 occurrences, often quickly turn into La Niña’s (Figure 1). La Niña is characterized by lower-than-normal temperatures across the central and east-central Equatorial Pacific and leads to largely the opposite impacts on weather, winds and currents. In contrast with El Niño, La Niña historically correlates with declining prices for agricultural goods. The likelihood that the current El Niño peaks soon and turns into a potentially strong La Niña by late 2016 or early 2017 is something that participants in agricultural markets should track closely because it has the potential to increase volatility and raise the cost of buying options as protection.

In terms of volatility, we observe the following consistent relationships across corn, soy and wheat:

1) Volatility during El Niño tends to be close to historical averages.

2) Volatility during La Niña significantly exceeds historical averages.

3) There is significant variation in volatility levels from one El Niño or La Niña episode to another.

4) The more intense the La Niña or El Niño episode, the greater the likelihood of higher than normal volatility.

Previously, we looked at the one-year change in the inflation-adjusted spot price from the time that the temperature index crosses an arbitrary threshold of +1 degree Celsius in the event of El Niño or -1 degree Celsius in the event of La Niña (Figure 2). To smooth out the data, we took a 20-business-day moving average of the first nearby futures (spot) price, which is approximately one month’s worth of data. For instance, if the temperature index crossed +1 degree Celsius above the moving average in September 1963, we looked at the return from the average price in September 1963 to the average price in September 1964. Here we focus on the annualized daily volatility in corn, soy and wheat.

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

http://www.cmegroup.com

18 NOVEMBER 2015

2

Figure 1: El Niño Often Turns Rapidly Into La Niña (1972-74, 1982-84, 1997-99 and 2009-10)

El Niño/La Niña: Sea Surface Temp. Anomalies

Source: NOAA, National Weather Service, Climate Prediction Center

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

Deg

rees

Ab

ove

or

Bel

ow

No

rmal

vs.

30

Yea

r A

vera

ge

El Niño

La Niña

1

2

3

4 5

6 7

8

9

10 11

1

2 3

4

5

6 7 8

12

2014

Figure 2: Inflation Adjusted Spot Returns In 1 Year After Crossing +/- 1 Degree Above/Below Normal

El Niño/La Niña: 1 Year Log Real Spot Returns

Source: NOAA, National Weather Service, Bloomberg Professional(C 1, W 1, S 1, BO1, SM1, RR1, LC1, LH1 and DA1, CPI INDX), Calculations Done by CME Group Economic Research

Corn Wheat Soybeans Soybean Oil Soybean Meal

Rough Rice Live Cattle Feeder Cattle Lean Hogs Dairy

13.2%

-4.2%

8.2%

-12.3%

16.9%

-10.6%

17.3%

-22.1%

23.7%

-19.7%

10.0%

-2.7%

5.1%

-6.3%

6.8%

-3.0%

6.2%

10.4%

20.4%

-4.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

El Niño La Niña

Volatility

Overall, volatility levels under significant El Niños are very similar to what they are under normal conditions. We define “normal conditions” as being when Pacific Ocean temperatures are between -1 and 1 degree Celsius of their normal. By contrast, when significant La Niñas occur, agricultural markets tend to experience much higher levels of volatility (Figure 3, 4 and 5). This may be related to the negative price trends observed after the Niño Index crosses the -1 degree threshold. Generally speaking, markets tend to be more volatile when they are declining than when they are rising, a relationship that holds true for energy, metals, equities and agricultural goods.

Higher volatility during La Niña holds equally true for corn, soy and wheat. That said, there is a high degree of variation within the different El Niño and La Niña episodes (Figures 6-11). One thing to note is that volatility, in general, was much lower during the 1960s than it has been subsequently.

There is also a relationship between the peak intensity of the El Niño or La Niña episode and the degree of volatility generated in agricultural goods prices. This relationship is stronger for La Niña than it is for El Niño and it tends to be stronger in soy than in corn, and especially strong for wheat (Figures 12-17). For each of these charts (Figures 12-17), we measure the correlation and the “p-value,” which is a statistical measure of the likelihood of getting such a strong result randomly, taking into account the correlation and the number of observations. A p-value of 5%, for instance, implies a 5% likelihood of getting such a strong correlation randomly, given the number of observations.

Figure 3: Corn Tends To Be More Volatile Under La Niña

Corn Futures 1959-2015: Realized Volatility in 12 Months After El Nino and La Nina Begin

Source: Bloomberg Professional (NOAAONI and C 1) for raw data with calculations from CME Group Economics

20.04%

27.96%

20.75%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

El Nino La Nina Neither

An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 4: Soy Tends To Be More Volatile Under La Niña

Soy Futures 1959-2015: Realized Volatility in 12 Months After El Nino and La Nina Begin

Source: Bloomberg Professional (NOAAONI and S 1) for raw data with calculations from CME Group Economics

20.27%

27.12%

22.27%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

18 NOVEMBER 2015

3

Figure 5: Wheat Tends To Be More Volatile Under La Niña

Wheat Futures 1959-2015: Realized Volatility in 12 Months After El Nino and La Nina Begin

Source: Bloomberg Professional (NOAAONI and W 1) for raw data with calculations from CME Group Economics

23.24%

33.50%

22.93%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 6: Corn El Niños

Corn Futures: Realized Volatility & El Nino


11.06% 9.42%

10.47%

30.24%

18.03%

23.74%

15.74%

13.87%

21.91%

18.60%

30.47%

26.33%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Aug '63 Jul '65 Jan '69 Jul '72 Sep '82 Nov '86 Nov '91 Dec '94 Jun '97 Oct '02 Oct '09 Jul '15

An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Twelve Months Beginning In...

Figure 7: Corn La Niñas

Corn Futures: Realized Volatility & La Nina



14.41%

36.50%

21.26%

12.60%

33.23%

21.19%

34.55%

36.86%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Jan '71 Aug '73 Jul '75 Dec '84 Jun '88 Aug '98 Oct '07 Aug '10

An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 8: Soy El Niños

Soy Futures: Realized Volatility & El Nino



14.62% 13.26%

5.59%

39.08%

21.91%

17.09% 15.07% 15.94%

21.13% 19.09% 19.99%

24.30%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 9: Soy La Niñas

Soy Futures: Realized Volatility & La Nina



13.43%

37.84%

27.70%

15.80%

32.62%

20.22%

34.86%

23.96%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 10: Wheat El Niños

Wheat Futures: Realized Volatility & El Nino



13.86% 13.33% 11.43%

32.82%

20.30% 20.17% 20.16%

22.52%

19.49%

28.71%

36.96%

26.63%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

3

18 NOVEMBER 2015

4

Figure 11: Wheat La Niñas

Wheat Futures: Realized Volatility & La Nina



16.57%

44.95%

31.89%

16.00%

27.64%

24.20%

47.20%

42.93%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%


An

nu

aliz

ed S

tan

dar

d D

evia

tio

n

Figure 12: Corn Volatility and El Niño Intensity: Correlation = 0.36, P-Value = 27%

Corn: Realized Volatility and El Nino Intensity


0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40

Vo

lati

lity

in 1

2 M

on

ths

Aft

er E

l Nin

o B

egan

Peak El Nino Intensity in Degrees Celcius Above Normal in Central/East Central Pacific Ocean

Figure 13: Corn Volatility and La Niña Intensity: Correlation = 0.68, P-Value = 6%

Corn: Realized Volatility and La Nina Intensity


Peak La Nina Intensity in Degrees Celcius Below Normal in Central/East Central Pacific Ocean

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2

Vo

lati

lity

in 1

2 M

on

ths

Aft

er L

a N

ina

Beg

an

Figure 14: Soy Volatility and El Niño Intensity: Correlation = 0.57, P-Value = 7%

Soy: Realized Volatility & El Nino Intensity



0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40

Vo

lati

lity

in 1

2 M

on

ths

Aft

er E

l Nin

o B

egan

Figure 15: Soy Volatility and La Niña Intensity: Correlation = 0.84, P-Value = 1%

Soy: Realized Volatility and La Nina Intensity



0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2

Vo

lati

lity

in 1

2 M

on

ths

Aft

er L

a N

ina

Beg

an

Figure 16: Wheat Volatility and El Niño Intensity: Correlation = 0.07, P-Value = 84%

Wheat: Realized Volatility & El Nino Intensity



0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40

Vo

lati

lity

in 1

2 M

on

ths

Aft

er E

l Nin

o B

egan

4

18 NOVEMBER 2015

5

Figure 17: Wheat Volatility and La Niña Intensity: Correlation = 0.54, P-Value = 17%

Wheat: Realized Volatility and La Nina Intensity



0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2

Vo

lati

lity

in 1

2 M

on

ths

Aft

er L

a N

ina

Beg

an

The fact that the current El Niño episode is quite intense creates the potential for elevated levels of volatility. Moreover, the possibility that the current strong El Niño could snap back into a powerful La Niña over the course of the next 12 months should also raise concerns about the potential for higher volatility in agricultural goods prices going forward. Nothing could be further from the market’s mind, however. Corn, soy and wheat options are trading near five-year lows in terms of implied volatility (Figure 18).

Figure 18: What, Me Worry? Corn, Soy and Wheat Implied Volatility Near Five-Year Low!

Corn, Soy and Wheat 90 Day ATM Implied Volatilities

Source: Quikstrike (OZC_90, OZS_90 and OZS_90)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15

Wheat

Corn

Soy

It wouldn’t surprise us if the current El Niño creates more volatility before it ends. So far, the current El Niño episode hasn’t generated big moves in agricultural goods prices. The U.S. and Canada had decent harvests of corn, soy and wheat while Argentina and Brazil have had bumper harvests of soy and wheat. Some even argue that El Niño might depress prices of agricultural goods since it might boost South American harvests. Perhaps, but we are skeptical of such arguments. We think that it is wiser to wait for an entire year or one full crop cycle to see what impact El Niño has on crop prices, and by our measure (one degree Celsius above normal), the current episode only began in June. This El Niño and its consequences will be with us for many months to come.

Bottom line:

• Implied volatility is very low on corn, soy and wheat options, which may represent a buying opportunity ifthe current strong El Niño generates higher-than-normal volatility.

• Volatility could soar if the current strong El Niño snaps back into a powerful La Niña, as was the case in 1973 and 1998.

• The stronger the episode of El Niño, the higher volatility tends to be, especially for corn and soy.

• The relationship between La Niña intensity and price volatility is even more powerful than with El Niño and applies to corn, soy and wheat.

• It’s too soon to evaluate the consequences of the current El Niño episode. We will need another 6-18 months to properly assess its impact.

• Watch the “delta” closely. As the current El Niño peaks, the rate at which the Niño Index declines may indicate how quickly the world will move towards a La Niña and how powerful any La Niña episode might be.

• In the short term, high levels of inventory in China and elsewhere might keep agricultural goods prices subdued.

5

ERIK NORLAND, SENIOR ECONOMIST AND EXECUTIVE DIRECTOR … · El Nino La Nina Neither Annuali z ed...

Documents

Transcript of ERIK NORLAND, SENIOR ECONOMIST AND EXECUTIVE DIRECTOR … · El Nino La Nina Neither Annuali z ed...