Abstract
This paper investigates variance risk premia in energy commodities, particularly crude oil and natural gas, using a robust model-independent approach. Over a period of 11 years, we find that the average variance risk premia are negative for both energy commodities. Energy variance risk premia in dollar terms are time-varying, while energy variance risk premia in return terms, particularly in the case of natural gas, are more constant over time. Finally, the return profile of a natural gas variance swap resembles that of a call option, while the return profile of a crude oil variance swap, if anything, resembles the return profile of a put option. The annualized Sharpe ratios from shorting energy variance are sizable. Although not nearly as high as the annualized Sharpe ratio of shorting S&P 500 index variance, they are comparable to those of shorting interest rate volatility or variance on individual stocks.
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