Statistical arbitrage in the freight options market : applying trading strategies to profit from volatility misspecification in the dry bulk shipping industry

Abstract

The purpose of this thesis is to investigate trading strategies that can exploit misspecification of volatility in the freight options market. We have, using observed market prices, derived smooth forward rate curves from daily observations. These forward curves promote a representation of the historical volatility term structures for the Capesize, Panamax, and Supramax sub-sector of the dry-bulk shipping industry. The volatility term structures present consistent behavior across vessel sizes, with increasing volatility over a six week time horizon before the volatility converges towards an apparent long term equilibrium. The dynamics coincides with the general belief that spot freight rates are mean reverting in the long term and positively auto-correlated in the short term. A comparison of the historical volatility term structure and the volatility estimates implied by the options market reveals differences. Based on deviating volatility estimates, we execute trading strategies in what we believe is a realistic representation of the market dynamics. Our findings can be interpreted as a sign of inefficiency in the freight options market. Keywords – Forward freight agreements, dry bulk, volatility term structure, volatility trading