KANSAS CITY, Mo.-(Dow Jones)--Volatility is shaking equity and commodity markets to their cores and is central to a discussion of why it remains expensive to trade these assets despite falling prices. Volatility is a measurement of the change in price over a given period of time, often expressed as a percentage. It is a factor used by commodity and stock exchanges to determine margin requirements - the capital or securities held in reserve to cover the risk of trading futures, securities or options - with price being the other major component to the formula.
Margin requirements have risen the past several months as commodity prices and equities traded to their summer highs. Since then, many of these markets have lost 50% or more of their value, yet the margins remain stout, reflecting the higher risk of doing business in a turbulent trading environment.
The markets have become "incredibly volatile," said Mary Haffenberg, spokeswoman for the CME Group in Chicago.
Corn futures for the year to Sept. 30 register a 36.2% average on the CME Group's historical volatility chart, up from an average of 31.4% in 2007 and up considerably from nearly 20% in 2000.
Soybeans are even higher, with a 44.3% reading so far in 2008, up from 21.7% last year and a 2000 average of 17.6%.
The volatility in equity markets has been well documented, and the S&P 500 contract has spiked 13.6% in the last three years. In the year to Sept. 30, the contract averages 23.5% in volatility, up from 15.2% in 2007 and just 9.9% in 2005, the CME data showed.
Exchanges rely on a system called SPAN, which the CME Group developed in 1991, a methodology that incorporates price changes as well as the markets' volatility to determine margin requirements. While prices in many commodities have tumbled 50% or more from their summer highs, their margins remain high because volatility in many instances has either remained constant or actually risen.
"It's the confluence of factors" - volatility and price - "that come together to determine margin requirements," said Sarah Stashak, director, investor and public relations at the InterContinental Exchange.
"Even if the prices come down, it is possible that volatility remains high," she said.
A leading indicator of volatility in the Standard & Poor's 500 Index is the Vix, often called the "fear gauge." On Tuesday, the Vix rose 2.84 points to close at 69.15 points.
Last Wednesday, the index reached its highest point since Oct. 29, rallying 8.2% to close the session at 66.5 points. That day also saw the Dow Jones Industrial Average fall 411 points, or 4.7 percent. The Vix, while off its yearly highs, continues to trade at lofty levels, suggesting traders' nerves are tightly wound as global economies tailspin into recession, with the U.S. teetering on the brink.
The cost of trading continues to escalate along with the explosiveness and unpredictability of the markets - with much greater price moves that seemingly occur on a daily basis.
"You've got a soybean market that moves 30 to 40 cents at a crack, corn moving 10 or 20 cents and wheat moving 30 or 40 cents at a time," said John Kleist, a broker/analyst at Allendale Inc. "What's the point of lowering margins by, say $300?"
"It almost becomes meaningless," he added.
Some analysts have said that the lack of enforcement in margin requirements in the equity markets is partly to blame for the current economic crisis. In 1995, then Federal Reserve Chairman Alan Greenspan called for the removal of margin requirements, in effect removing a valuable safety net for the exchanges.
Some margin requirements have actually been reduced in recent weeks. ICE Futures U.S. lowered margins on coffee, cocoa and frozen concentrated orange juice, though it raised margins on the exchange's Continuous Commodity Index. The CME Group, however, recently raised minimum margins on live cattle, citing the volatile markets.
In addition, the increase of large index funds doing business on the trading floors have in effect made it more expensive for the smaller traders.
"Because of the margins put on index funds, and they generally have the greatest risk capacity, how can you lower them for the little guys?" said Kleist. "And that is where a lot of these margin calls came from with the influx of index funds into the pits."
