Volatility Factor Calculation Methodology
BNA Article By Liz White
RMA uses a measure of price volatility based on the Black-Scholes Model, which is commonly used and accepted in finance. This model provides a formula that translates options prices (the amount the market charges to "lock-in" a future price) into an implied volatility of the price of the commodity. This price volatilit is used in the calculation of RMA's premium rates for revenue coverage. The result is that premium rate RMA charges to lock-in a future (harvest time) price through crop insurance is equivalnt to what the market charges to lock in a price through an options contract.
Implied volatility, being a common market measure, is provided by a number of financial reporting services. RMA utilizes the services of barchart.com as its source for market data. For this calculation, RMA downloads the appropriate closing implied volatility for the contract, for the day, as defined in the Commodity Exchange Price Provisions (CEPP) of the Common Crop Insurance Policy Basic Provisions (11-BR). The implied volatility is then adjusted to take into account the time difference between the expiration of the options contract and the time period RMA uses to establish the harvest price. The RMA Volatility Factor for a given crop is based on the average of the time-adjusted volatility factors for the last 5 days of the projected pricing period.
STEPS USED BY RMA TO ESTABLISH THE VOLATILITY FACTOR
Determine the Projected Price and Harvest Price monitoring perios from the CEPP. For each of the last 5 days of the Projected Price discovery period:
EXAMPLE: IOWA CORN
Contract |
Date |
Implied |
RMA calculated |
CZ10 |
2/22/10 |
.336 |
.287 |
CZ10 |
2/22/10 |
.323 |
.276 |
CZ10 |
2/22/10 |
.323 |
.275 |
CZ10 |
2/22/10 |
.323 |
.275 |
CZ10 |
2/22/10 |
.326 |
.277 |
Simple average of the 5 RMA calculated volatility factors, rounded to 2 decimals=.28
RISK MANAGEMENT AGENCY, February 2011