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Faith in OPEC Deal Turns Options Traders Into Oil Bulls

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Written by Gunjan Banerji

Click HERE to Read the Article by the Publisher.


Oil prices have jumped 8.7% since Nov. 14 when OPEC said its members agreed to cut output. Options players are betting on another 17% run-up in prices.

As of Friday, traders have concentrated on contracts that pay out when West Texas Intermediate hits $55 a barrel. While prices of crude futures have been whipsawed by uncertainty ahead of the Organization of the Petroleum Exporting Countries’ meeting this week, market participants have built up bullish positions in options.

Open interest, or the number of contracts outstanding, of $55 WTI calls that expire in January has nearly doubled in the last month, according to QuikStrike, an options pricing and analysis tool that uses data from CME Group Inc., the world’s largest operator of derivatives exchanges.

On the bearish side, investors have coalesced around a strike—the level at which an option can be exercised—of $40, with 26,557 contracts of puts outstanding at that price. That falls short of the 30,254 calls at $55 as of Nov. 25, a level oil hasn’t surpassed since July 2015. Overall, calls on crude futures outnumber puts by a ratio of five to four, data show.

“There’s a lot of upside trading activity,” said Nick Howard, chief executive officer at QuikStrike.

Some investors are using options to bet the swing will be wild, whether up or down, by using a trade known as a straddle, which involves buying both puts and calls, according to Commodity Research Group. “There are so many scenarios that you can think of that are possible” that a bet on futures is too risky, said CRG’s Jim Colburn. “Just buy volatility.”

Oil market participants have been speculating OPEC, the 14-member cartel that controls one-third of the world’s crude production, could strike a deal to slash production. On Nov. 21, Goldman Sachs raised its forecast for oil in the first half of 2017 to an average of $55, citing expectations of lower production.

The open interest in strike prices spanning between $50 and $55 is roughly twice what it normally would be for January and February contracts in WTI and Brent, the U.S. and global benchmarks for oil, respectively, said John Gretzinger, head of energy at INTL FCStone, a financial services firm, noting there has been a lot of hedge-fund and buy-side interest recently.

OPEC members such as Saudi Arabia and Iran have said they want prices to return to a range of $55 to $60 a barrel, a level that would stop the bleeding in their national budgets.

Not all traders and investors are sold on the trade. Analysts at Credit Suisse said if OPEC fails to agree on production cuts, U.S. oil could fall to $35 a barrel at the beginning of next year—a price level at which options players have also increased hedges.

Questions remain over how much OPEC is willing to cut, said Rob Haworth, a senior investment strategist at U.S. Bank Wealth Management.

“Unless OPEC can really cut production and deliver on that, we’re still a year away from this market getting back into balance,” Mr. Haworth said.

The buildup in the options markets ahead of the meeting could lead to a seismic unraveling that adds to selling pressure should OPEC disappoint, Mr. Gretzinger said.

“The stakes are higher,” he said. “The positions are bigger than they normally are.”

Trading volumes have shot up. The average daily volume of WTI options hit an all-time record on Nov. 15 of about 430,000 contracts traded, according to the CME Group.

While CME launched weekly crude options in 2014, the popularity of these shorter-dated contracts took off this year, said Jeff White,senior director of energy products at CME Group. Weekly crude oil options trading is up 54.5% year-over-year as of Friday, according to CME.

“Weekly options give traders even more granularity around market-moving events,” Mr. White said. “More volume stems from increased participants in the oil market in general.”


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Written by Gunjan Banerji

Click HERE to Read the Article by the Publisher.

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