As crude hits $50 a barrel, options market suggests jitters

*Oil drilling rig.

*Oil drilling rig.

28 May 2016, London — With the price of oil finally touching $50 a barrel this week, producers and speculators have been loading up on options to protect themselves from a downside risk, signaling there are still some jitters surrounding the recent rally.

Deep out-of-the-money put options – options that would not be profitable until a substantial pullback in the price of oil – have shown a marked increase in implied volatility, a sign that producers are locking in prices close to levels for them to be profitable while speculators are protecting themselves from a potential correction.

U.S. crude has nearly doubled from 12-year lows touched in February. Market sources say much of that rally was fueled by the perception of the improving fundamental picture, with falling U.S. output and global supply outages helping to rebalance a market reeling from oversupply for nearly two years.

That has prompted hedging among producers. The current put skew – the difference in implied volatility for out-of-the-money and in-the-money options – is fairly typical of a market where producer hedging is prominent

John Saucer, vice president of research and analytics at Mobius Risk Group in Houston, said implied volatility has lately been cheap, making options attractive for those either protecting against or betting on the downside.

Options expiring in 12 months show a strong bias in favor of out-of-the-money puts, which are trading at a much higher premium than similar out-of-the-money call options. That’s in part due to producer hedging, which involves selling those long-dated calls while buying puts or put spreads.

On Friday, the most actively traded are the $44 July puts, which had traded over 3,300 lots by noon ET (1600 GMT).

Among longer-dated options, open interest in the $40 December 2016 puts has spiked 10 percent in the last 10 days to nearly 35,000 contracts. Open interest in $45 Dec. 2016 puts have risen about 10 percent in a similar time frame.

For December 2017 maturities, the two most active options were the $40 and $45 puts.

With crude at $50 a barrel, hedging could intensify, said Jesper Dannesboe, senior commodity strategist at Societe Generale. Next month’s meeting of the Organization of the Petroleum Exporting Countries (OPEC) added to concerns.

“Whether you’re bullish or bearish, you’re going to have jitters going into this week because you’ve got this huge variable event and there’s some level of uncertainty,” Saucer said.
*Devika Krishna Kumar; Editing – Alistair Bell – Reuters

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