Traders in the oil market are facing unprecedented levels of volatility. Numerous factors are driving uncertainty in the outlook for oil inventories. Demand levels can vary widely based on the extent of the global recession, winter heating needs, and China’s response to COVID-19 levels. Supply can be impacted just as widely by OPEC, U.S. Strategic Petroleum Reserve policy, and Russian sanctions. As information on these variables evolves, markets tend to respond.
Micro WTI Crude Oil options are smaller-sized contracts that give traders the flexibility to address oil market volatility with lower dollar premiums. Weekly Micro WTI options, expiring each Friday, can provide precision for hedging around near-term calendar events. Monthly options contracts trade twelve months out into the future, allowing traders to express longer term points of view.
Looking for ideas on how to manage oil market volatility? Here are a few examples of how traders can use Micro WTI Crude Oil options and CME Group volatility tools.
Example 1: A trader uses call spreads to reduce premium
It is Monday and a trader notes on the Economic Event Analyzer that there is an inflation report on Thursday. He believes the report is likely to be a catalyst for crude oil to move back to the high end of its range, an increase of $3.00 per barrel. An at-the-money (ATM) call option expiring on Friday is priced at $2.80 per barrel. The trader sees on QuikStrike that the market has developed more call skew than usual and seeks to use call spreads to lower his hedging cost.
- Strategy: Buy Micro WTI Weekly call spreads on the most-prompt Weekly contract
- Month one WTI is trading at $80 per barrel
- Buy three weekly calls with a strike of $82 per barrel for $2.00
- Sell three weekly calls with a strike of $86 per barrel for $1.50
- Pay a net premium of $150 ($2.00 x 3 contracts x 100 - $1.50 x 3 contracts x 100)
- Results: On Friday, the expiration date of the call options, WTI crude oil settles at $83, as the trader expected.
- Trader collects on the call purchase ($83 - $82 Strike) x 3 contracts x 100 = $300
- Trader owes zero on the calls he sold
- Trader earns a profit of $150, double the initial premium paid
Example 2: A trader uses a strangle strategy to express a point of view on volatility
A trader notes that oil has been rangebound in a $6 band around $85 for the last few weeks and that implied volatility is setting near-term lows (CME Group’s Crude Oil CVOL Index has fallen to 46%). However, she believes that upcoming geopolitical talks and end-of-quarter rebalancing in the next six weeks is likely to be a catalyst for greater movements in the crude oil market. She believes oil price will move well outside its recent band – though she is unsure in which direction.
- Strategy: Buy a strangle on the second most prompt monthly WTI Micro Crude Oil futures expiring in seven weeks:
- Buy one out-of-the-money call with a strike of $91 for $2.80
- Buy one out-of-the-money put with a strike of $79 for $2.40
- Trader pays a net premium of $520 ($2.80 x 1 x 100 + $2.40 x 1 x 100)
- Results: Four weeks later, crude oil has risen to $98 per barrel, outside the $6 band, and the $91 call is in-the-money. The trader notes that CVOL has also risen back to 53%, and with two weeks before expiration, even the $79 put still has some value. She decides to exit the trade now rather than waiting until the options expire.
- She sells the $91 call for $7.75 vs. $7 if it had expired with the market at $98: $775
- She sells the $79 put for $0.25 vs. $0 at expiry: $25
- She collects $800 on her options, for the net profit of $280
Example 3: A trader manages an implied short crude oil position with monthly call options
A trader has a portfolio of approximately $30K in investments. Recently, he has noticed negative correlation between the portfolio and the large moves in the price of WTI crude oil. The trader believes that for every $10 increase in WTI the portfolio will decline approximately 2%, or $600, and wants some protection against large WTI price increases of $20 or more over the next month.
- Strategy: Buy Micro WTI Crude Oil call options on the second most-prompt WTI contract
- Month two WTI is trading at $90 per barrel
- Buy one call on Month two WTI Micro Crude Oil futures with a strike of $110
- Pay $4.00 in premium or $400
- Results: On the expiration date of the call options, WTI crude oil settles at $118.50, and the trader’s original investment portfolio has declined by $1,800.
- Trader collects $1,850 on the option: ($118.50 - $110 strike) x 1 contracts x 100
- Trader earns a profit over the premium paid and has offset some of the original investment portfolio losses
With oil market volatility high and the market sensitive to events, options will continue to be an attractive choice for traders. Traders looking for insight on options can access a variety of tools via CME Group’s website or the CME Direct platform. The QuikStrike platform offers a comprehensive suite of options tools, including pricing analytics and options “greeks” and tools to test out strategies, and can be accessed via the web or through CME Direct. Traders looking for real-time or historical views on volatility can access CVOL via Quikstrike or directly on the CME Direct platform. The Economic Events Analyzer and the OPEC Watch Tool can assist in understanding and taking action around upcoming potentially market-moving events. For traders looking to improve their options knowledge, CME Group’s website provides an entire suite of free courses covering options from basics to complex strategies. For more on using Micro WTI Crude Oil options, see Turning Ideas Into Action, or watch this educational course.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. This report and the information herein should not be considered investment advice or the results of actual market experience.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.