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Choosing Time to Expiry and Intraday Volatility for Commodity Options

Article Quant Q&A · Author: Ted Graham
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Summary

The document discusses how practitioners might measure time to expiry when valuing commodity options on futures. It frames the choice between calendar-day and business-day conventions as dependent on how theta is accumulated and how volatility estimates compare across the weekend. The answer suggests that calendar time may suit oil, where weekend geopolitical developments can matter, while business time may be more appropriate for a market such as cotton.

For intraday time decay, the response argues that equal clock-time intervals need not represent equal risk. Realized volatility can vary by time of day, with activity around the pit opening and settlement tending to be higher, and scheduled data releases may add event-specific volatility. A precise model could therefore weight time according to expected volatility patterns. These are practitioner judgments and examples, not a universal CME convention or an empirically validated prescription; the document does not settle on a single standard.

Key ideas

  • The choice between calendar days and business days depends on how the market behaves over weekends.
  • Weekend event risk can make calendar time relevant for some commodity options.
  • Intraday volatility is uneven, so clock hours may not capture time value equally well.
  • Market openings, settlement periods, and scheduled releases can call for time-varying volatility assumptions.
  • The response offers practitioner guidance rather than a binding convention.

Tags

CommoditiesOptionsVolatilityDerivatives pricing
Full text
# Commodity options time to expiry conventions?


# Commodity options time to expiry conventions?












For CME's futures options, do most participants use a 365 day convention or a 252 day convention? I realize that it is our choice, but I'm interested in hearing from practitioners about what is common.

Then within each day, is it usual to only take out time during the active trading hours (say 5:00-14:30 ET for crude oil) or do you take out time according to the wall time passing?

Edit: a related question (with some informative answers) is Ways of treating time in the BS formula. But I'm still interested in answers related to CME.

## Answer by Bram (score 2)

https://quant.stackexchange.com/a/34883

As you mention, it's your own choice; I see the crux of this matter in two points: the first is how you accumulate your theta and the second is how good your volatilities on Friday look versus on Monday.

I'd personally be inclined to use calendar days for something like oil (I would expect that the chance of a geopolitical event such as a war starting over the weekend is at least 2/7th), while for something like cotton I'd be more inclined to use business days.

During the day: I have never bothered with this, but I guess if you're looking to be a market maker you should. The thing here is that not all hours are equal. If you look at intraday measures of realized volatility, you'll see that around the pit opening and around settle are typically more volatile than other hours in between. So ideally you would account for that. Additionally, on days on which numbers are published, you would also expect some potential additional volatility around them for which you could adjust. So I wouldn't use either or what you are suggesting if you want to be really precise about this.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.