Smooth Futures Options Vol Surface in terms of underlying underlying

[JackRab]

You're right, that is probably the answer. I need to figure out a conversion formula for options on later futures expiries so that I can create a consistent curve going out to 2021. My expience with options on rates derivatives or even rates futures themselves is limited so I'll have to hunt around for the correct formula.

I think I am

You need to know the volatility difference between the futures. So in interest rate markets... it's about duration etc. I'm not an expert in bonds etc, but keep in mind... a longer date bond moves more than a short term one. So you need to figure out the relationships between say the 2 year and 5 year... etc... that will be your starting point.

 

[sle]

It's not a trivial task. For cash and carry underlying, you should have a perfect surface (unless there is some sort of carry uncertainty). For non fungible futures you need a model of the curve which will be different for each product. E.g. for Eurodollar futures you can use something like LMM.

May the force be with you, cause you are entering a seriously hairy territory.