As Supply Shortage Drags On, Crude Option Traders Brace for Sharp Price Swings
Crude oil option traders are bracing for both sharp increases and steep declines in underlying crude futures contracts amid continued uncertainty over restoring vital global oil flows three months into the Middle East war.
The latest CME Group exchange data as of Thursday showed the most traded strike prices for the July West Texas Intermediate crude put options were $80, $85 and $70, while the most active July call strikes were $120, $100 and $110. The July WTI options will expire in mid-June.
The highest open interest — another key liquidity gauge measuring the total number of outstanding options — was in the $75, $70 and $80 July put strikes, and the $105, $106 and $120 calls.
Unlike futures, a put gives the owner the right, but not the obligation, to sell an underlying crude futures contract at a certain strike price within a timeframe, while a call offers the owner the right to buy.
With the July WTI contract settling at just below $90/bbl on Thursday, the large number of actively traded out-of-the-money options suggests many market participants are either hedging or betting that the price of WTI contracts could rise or fall sharply from current levels.
An option is considered out of the money if it has no intrinsic value — i.e., when a put’s strike price is below the underlying futures price, or when a call’s strike price is above the futures price.
Capital Economics said in a note this week that oil market options data suggest investors expect oil prices to ease over the next three months, but they have “unusually low conviction” due to the ongoing uncertainty around the Strait of Hormuz.
The London-based research firm said its option-implied probability distribution model indicates the upside skew in investors’ expectations for oil prices has “greatly diminished” since the start of the Middle East war. However, the price outlook in three months’ time has also become increasingly uncertain as the conflict has progressed, it added.
Capital Economics said oil market investors are “caught in limbo” as traders are cautious of possible rallies or pullbacks. “Investors are still implicitly placing a 37% chance on oil being above $100/bbl in 3 months,” the firm said.
The CBOE Crude Oil ETF Volatility Index — which measures the expected 30-day volatility for the options of the U.S. Oil Fund ETF —fell to around 57 on Friday from 121 on March 11. It was also well below an all-time high of 235 on April 20, 2020, when WTI settled at a negative price due to Covid-19 demand destruction.
David Thompson, executive vice president of energy futures brokerage Powerhouse in Washington D.C., said the backwardation in crude futures suggests that market participants are willing to pay more now than in the future because of short-term supply worries. It is not an indication that futures prices are likely to drop in the future, he added.
“It’s the same thing for options. Any option value is a snapshot at this moment in time, as opposed to a necessary predictor of something,” Thompson said.
–Reporting by Frank Tang, ftang@opisnet.com; Editing by Allegra Fradkin, afradkin@opisnet.com
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