Horizontal Spreads: Using Weekly Crude Oil Options to Lower Trading Costs
Weekly WTI Crude Oil options have grown in popularity over the last two years, driven by their targeted risk exposure and lower premiums. In response to trader demand, CME Group has expanded the suite of Weekly option expiries from Fridays to expiries for every day of the trading week, available to trade four weeks into the future.
The abundance of expirations now available for Weekly Crude Oil options creates new opportunities for hedging portfolios and capturing asymmetric risk. The work below demonstrates how traders can use a combination of a long and short WTI option position across different weekly and monthly expiries. These positions, often called horizontal spreads or calendar spreads, allow traders to hedge or express points of view on price or volatility across different time windows, and benefit from lower trading costs.
Short term protection for a bear portfolio with a long horizontal weekly call spread
A trader has built a portfolio that is short WTI futures, reflective of his bearish view around spare capacity and the economic outlook at high oil prices. The trader is concerned that increasing geopolitical instability could drive prices higher over the upcoming long weekend and is looking for a hedge against rising prices.
Example 1
On August 26, October crude oil is trading at $86 per barrel. The trader buys a $90 call option expiring the following Friday, September 4, paying $0.50. He also sells a $90 call option expiring Tuesday, September 1, right after the holiday weekend, for $0.20, net paying $0.30 between the two trades.
Assume the trader is correctly concerned about escalating geopolitical risk and rising prices. The market settles on Tuesday at $89.50, with volatility also climbing. The Tuesday call option expires out of the money and is worth zero. The increasing moneyness and volatility drives the Friday option up to $2.30. The trader can decide to close out the position, selling the Friday call for $2.30, netting $2.00 on the option strategy ($2.30 less the $0.30 in premium paid). He may also choose to hold the call until expiry with downside in the trade fixed at the $0.30 net premium paid.
If the trader were incorrect and the market remained at $86 or fell, the Tuesday call would expire out of the money. The Friday call would also decline in value and the trader can decide whether to sell it for its residual value or let it expire worthless, losing a maximum of the $0.30 net premium paid.
Expressing an OPEC point-of-view with short horizontal put option position
A trader notes that the oil market has been range-bound with WTI trading between $73 and $76. She expects that this will remain so until the next OPEC meeting on November 30 — 10 days later, which could be a catalyst for prices to move sharply lower.
Example 2
The trader considers buying a $73 strike put option on January WTI, with a premium of $2.75. However, she’s unsure the move lower will be sufficient to cover this cost. Since she expects a range bound market for the next two weeks, she decides to also sell a $73 put expiring the Friday before the OPEC meeting, which is priced at $1.85. The trader has lowered the cost of entering the trade from $2.75 to $0.90.
