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How to Calculate Volatility With Spot and Strip Prices

Original post by Michael Wolfe of Demand Media

"Strip price" and "spot price" are terms used when discussing natural gas or crude futures. Futures contracts are contracts that provide the bearer the right to purchase a set amount of a given commodity on a set day in the future. The spot price is the price that a person would pay at the site of production were he prepared to take delivery, while the strip price is the average daily settlement price for the next 12-months contract. Volatility can be calculated by using historical price data for contracts.

Step 1

Collect historical price data. The first step in measuring volatility in a commodity is to collect as much price data as you can. For example, if attempting to determine the volatility of Nigerian light, sweet crude, you would need to draw a record of spot prices for one or more locations -- preferably one, for simplicity -- from someone keeping these records. Many oil companies, as well as financial services firms that follow the oil industry, keep such records. In addition, many online publishers of financial data do as well.

Step 2

Enter the data into a spreadsheet. If the data that you've received has been provided to you in the form of an electronic spreadsheet -- which is definitely preferable to another kind of electronic document and certainly preferable to paper -- you will need to enter it into one. This can be tedious, but the amount of time that this takes will depend on the length of this historical volatility that you wish to calculate. If you wish to go back only a few months, it shouldn't take long; 10 years, however, could take a while.

Step 3

Analyze the data and graph it. When the data has been entered, you should then attempt to analyze it for patterns. All analysts have their own metrics for volatility, with each tending to prize his own formula for determining an asset's relative stability. However, if you don't have a set formula, you may wish to graph the data out and observe the spot and strip price fluctuations over time. This will give you a good visual rendering of volatility that words simply can't match.

                   

Tips & Warnings

  • Remember, volatility is always relative. To get the idea of the volatility of a particular kind of natural gas or crude, compare it to another variety. Or else compare it to another commodity entirely.

References

  • "International Crude Oil Handbook, 2010"; Energy Intelligence Group; 2009

About the Author

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.

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