The Lemon Fool

I have been trading WTI options for some time, but don't recall seeing anything as nutty as the current market. I am short APR puts, maturing in 13 days, at a strike of 70. Underlying futures price is 114, so the 70 puts are 39% out of the money. In a normal market, the puts would be worthless, but they are trading around 8c, with implied volatility a whopping 90%. I am short MAY puts, 41 days to expiry, at the same strike and they are trading with implied vol of 70%. As the price of oil has gone up, so has the implied volatility, significantly holding up the premium.

Can anyone explain what is going on in the oil market? It is as though there was a fear of a huge collapse in price coming in the next few weeks. Is that likely?

I don't know too much about the oil market. More generally we tend to associate high volatility with declining markets but sharp spikes in the price of an underlying is also a form of volatility, and would raise the premia of both call and put options, especially the near-dated ones.

If the market perceives that oil is being propped up by the war in Ukraine then it would also perceive that a sudden ceasefire could cause the oil price to plummet. Deep out-of-the-money put options might be an attractive and cheap way to mitigate the tail risk of a sudden dramatic reversal.

Or investors could be buying put options closer to the money and then buying OOTM contracts as part of a vertical or calendar spread trade.

Finally there is the phenomenon of the volatility smile, where contracts that are the furthest out of the money have elevated premia because they are harder to hedge.

That's all I've got but my options activity is restricted to equities and metals. Gold and silver have been on the hoof recently as well.

joey wrote:(Without meaning to de-rail your thread) Can I ask what kind of strategy or strategies you are employing? I have recently been considering using options, and so have been learning whatever I can about the various approaches. It would be interesting to hear from someone who is running an account. BTW I follow the oil markets quite closely but I'm afraid I can't explain the pricing oddity --- other than by saying that the Fear vs. Greed-o-meter must be doing strange things this week....

I keep things very simple, using either bull put spreads or (mostly) naked puts. I have mostly be trading equity index options (S&P 500, DAX) for the past few years, but have kept out of the equities market since Ukraine starting looking a threat and just concentrate on oil for now. I just don't think that the risks in equities markets are properly reflected in current implied vols, so prefer to stay out. I might go back in if/when we get a large volatility spike and if I did I would use a put spread rather than naked puts.

Getting back to oil, what I am really interested in is what scenarios would cause a short term collapse of 30% or more in the price of oil. I just cannot think of any besides maybe a coup in Russia ousting Putin.

ps, implied vol down slightly overnight, but still very elevated.

Lootman wrote:I don't know too much about the oil market. More generally we tend to associate high volatility with declining markets but sharp spikes in the price of an underlying is also a form of volatility, and would raise the premia of both call and put options, especially the near-dated ones.

If the market perceives that oil is being propped up by the war in Ukraine then it would also perceive that a sudden ceasefire could cause the oil price to plummet. Deep out-of-the-money put options might be an attractive and cheap way to mitigate the tail risk of a sudden dramatic reversal.

Or investors could be buying put options closer to the money and then buying OOTM contracts as part of a vertical or calendar spread trade.

Finally there is the phenomenon of the volatility smile, where contracts that are the furthest out of the money have elevated premia because they are harder to hedge.

That's all I've got but my options activity is restricted to equities and metals. Gold and silver have been on the hoof recently as well.

The volatility surface is as wierd as the high IV. For the APR expiry, the at the money IV is 77% (!), with the underlying about 112. For lower strikes, the IV actually drops until you get to a strike of about 90, with IV "only" about 60%. After that IV starts to rise, matching the at the money IV for a strike around 77. At my strike of 70, IV is 85%. It is a similar story for MAY expiries, but not so pronounced, with the IV skew bottoming out at -5% for the 95.5 strike. JUN smile looks more "normal".

Maybe this is not unusual for oil options, but I don't recall noticing it before.

joey wrote:Such high oil prices could initiate a global recession. Perhaps that is what some people are expecting. However, depends on the timeframe one is looking at. Certainly April and May expiries would surely be too early for that, if it were to happen?

This is my feeling, but I do like to look gift horses in the face

hiriskpaul wrote:

Lootman wrote:I don't know too much about the oil market. More generally we tend to associate high volatility with declining markets but sharp spikes in the price of an underlying is also a form of volatility, and would raise the premia of both call and put options, especially the near-dated ones.

If the market perceives that oil is being propped up by the war in Ukraine then it would also perceive that a sudden ceasefire could cause the oil price to plummet. Deep out-of-the-money put options might be an attractive and cheap way to mitigate the tail risk of a sudden dramatic reversal.

Or investors could be buying put options closer to the money and then buying OOTM contracts as part of a vertical or calendar spread trade.

Finally there is the phenomenon of the volatility smile, where contracts that are the furthest out of the money have elevated premia because they are harder to hedge.

That's all I've got but my options activity is restricted to equities and metals. Gold and silver have been on the hoof recently as well.

The volatility surface is as wierd as the high IV. For the APR expiry, the at the money IV is 77% (!), with the underlying about 112. For lower strikes, the IV actually drops until you get to a strike of about 90, with IV "only" about 60%. After that IV starts to rise, matching the at the money IV for a strike around 77. At my strike of 70, IV is 85%. It is a similar story for MAY expiries, but not so pronounced, with the IV skew bottoming out at -5% for the 95.5 strike. JUN smile looks more "normal".

Maybe this is not unusual for oil options, but I don't recall noticing it before.

Another wierd thing I was going to mention are some unusually large differences in IV when calculated using calls instead of puts. For some reason these are not being quickly arbitraged away.

hiriskpaul wrote:Getting back to oil, what I am really interested in is what scenarios would cause a short term collapse of 30% or more in the price of oil. I just cannot think of any besides maybe a coup in Russia ousting Putin.

thinking aloud.....
would the current situation with Russia's dependence on oil, plus US domestic discomfort with fuel prices/inflation lead to a situation where the USA swallows their reservations and pulls Iran back into the market make for a big impact on price? Didn't think the volume they produce to have as much price delta as being implied...

TUK020 wrote:

hiriskpaul wrote:Getting back to oil, what I am really interested in is what scenarios would cause a short term collapse of 30% or more in the price of oil. I just cannot think of any besides maybe a coup in Russia ousting Putin.

thinking aloud.....
would the current situation with Russia's dependence on oil, plus US domestic discomfort with fuel prices/inflation lead to a situation where the USA swallows their reservations and pulls Iran back into the market make for a big impact on price? Didn't think the volume they produce to have as much price delta as being implied...

I thought the Iran situation was close to being resolved anyway. Now of course Iran has gained a little more leverage, which might delay the nuclear agreement.

hiriskpaul wrote:

TUK020 wrote:

hiriskpaul wrote:Getting back to oil, what I am really interested in is what scenarios would cause a short term collapse of 30% or more in the price of oil. I just cannot think of any besides maybe a coup in Russia ousting Putin.

thinking aloud.....
would the current situation with Russia's dependence on oil, plus US domestic discomfort with fuel prices/inflation lead to a situation where the USA swallows their reservations and pulls Iran back into the market make for a big impact on price? Didn't think the volume they produce to have as much price delta as being implied...

I thought the Iran situation was close to being resolved anyway. Now of course Iran has gained a little more leverage, which might delay the nuclear agreement.

Yes USA and Europe wants Iran's oil and gas back in the market. Russia is finding last-minute objections to the agreement, so it will be interesting to see if USA and Europe do a deal with Iran regardless.

bruncher wrote:

hiriskpaul wrote:

TUK020 wrote:

hiriskpaul wrote:Getting back to oil, what I am really interested in is what scenarios would cause a short term collapse of 30% or more in the price of oil. I just cannot think of any besides maybe a coup in Russia ousting Putin.

thinking aloud.....
would the current situation with Russia's dependence on oil, plus US domestic discomfort with fuel prices/inflation lead to a situation where the USA swallows their reservations and pulls Iran back into the market make for a big impact on price? Didn't think the volume they produce to have as much price delta as being implied...

I thought the Iran situation was close to being resolved anyway. Now of course Iran has gained a little more leverage, which might delay the nuclear agreement.

Yes USA and Europe wants Iran's oil and gas back in the market. Russia is finding last-minute objections to the agreement, so it will be interesting to see if USA and Europe do a deal with Iran regardless.

Meanwhile, the APR22 WTI future hit $130 early this morning, up from $115 Friday. Back down to $123 now.

Gas is even worse, with the APR22 UK Natural Gas future hitting 800, up from 460 on Friday and 224 on Friday 25 Feb. A year ago it was about 44. Now back down to "only" 680.

There is a lot of talk about sanctioing Russian oil and gas, but is this actually feasible or just ignorant posturing by politicians? With gas in particular can European/UK consumers and industry afford not to take Russian gas? Even if it was affordable, could the oil and gas be logistically supplied without some form of rationing?

hiriskpaul wrote:Meanwhile, the APR22 WTI future hit $130 early this morning, up from $115 Friday. Back down to $123 now.

Gas is even worse, with the APR22 UK Natural Gas future hitting 800, up from 460 on Friday and 224 on Friday 25 Feb. A year ago it was about 44. Now back down to "only" 680.

There is a lot of talk about sanctioing Russian oil and gas, but is this actually feasible or just ignorant posturing by politicians? With gas in particular can European/UK consumers and industry afford not to take Russian gas? Even if it was affordable, could the oil and gas be logistically supplied without some form of rationing?

Nutty indeed - and there's been random ones like nickel going crazy today. Risk managers must be tearing their hair out.

Regardless of what the politicians say, there's already de facto sanctions by the West on Russian oil as people just can't pay for it. [url=
https://www.spglobal.com/commodity-insi ... inus-2787b]S&P reckon[/url] that effect alone should cut 1-2mmbbls from their 4.5mmbbls of crude exports, and their 2.5mmbbls of product exports (mostly diesel and fuel oil) will also be hit.

But of course oil is far more fungible than gas, so if China/India just replaces purchases from the Gulf (at Brent-like prices) with Russian oil at Brent minus $30 or more, and then Europe buys from the Gulf, then everybody's happy apart from European consumers.

Gas is more difficult - and is less important to Russia financially. At least the exceptionally warm winter has meant that EU stocks are now just about back within the 5-year range for the time of year, when they were >10bcm below the range in November. Napoleon lost in Russia to "General Winter", Putin may have lost his gas war thanks to it being a bit mild for the time of year.

perhaps the puts are so highly priced because investors that buy oil or future oil contracts are buying put options to limit their loss if they are wrong in their bet on high prices.

i have no experience in oil markets, only in stock markets.

look wrote:perhaps the puts are so highly priced because investors that buy oil or future oil contracts are buying put options to limit their loss if they are wrong in their bet on high prices.

i have no experience in oil markets, only in stock markets.

I am sure that is the case, but it is still strange market. Futures prices are substantially down today, but implied vol is also substantially down! Being short puts a falling price is not what I want, but I welcome the drop in implied vol.

If it's any consolation, the bosses of the big trading houses are somewhat bemused too - but who cares as long as there's lots of volatility to trade, right lads?

https://www.reuters.com/business/top-tr ... 022-03-22/

Bloomberg commodities guy highlights the crazy backwardation in the European diesel market at the moment, reflecting the lack of inventory anywhere :

Hallucigenia wrote:If it's any consolation, the bosses of the big trading houses are somewhat bemused too - but who cares as long as there's lots of volatility to trade, right lads?

https://www.reuters.com/business/top-tr ... 022-03-22/

Well I am going to keep on selling WTI puts, but no more than 28 days out as there is a substantial drop off in implied vol for further out expiries. Short at $70 and $71, expiring 14 April. Should be safe enough, but occasionally still seeing implied vol rising with the oil price, which makes litle sense.

True to form in this bonkers market, price falls substantially, but impled vol collapses!