Client:

Trader with a directionally biased portfolio of Crude Oil futures and options

Challenge:

Hedge event-driven risk over a weekend and into the following week

Solution:

Use WTI Weekly options to hedge adverse price movement

Overview

A trader is managing risk of a complex portfolio of crude oil futures and options. The portfolio’s profile is directionally biased to profit when crude oil futures prices drop. 

There have been multiple news headlines from oil-producing nations about impromptu meetings to discuss reducing crude oil production.

The trader is concerned that a surprise announcement of a decrease in oil production will send crude oil futures prices soaring, resulting in PnL losses to his portfolio.

Approach

Crude Oil Weekly options are designed to protect a portfolio against adverse short-term price movements while enhancing the portfolio’s overall returns.

The trader needs to protect against a price move of $3.00 or more over the next five to seven calendar days. He plans to purchase WTI Crude Oil Weekly call options that expire on the subsequent Friday. 

Front-month WTI Crude Oil futures are trading at $70.75 per barrel. The trader sends an RFQ to CME Globex for the WTI Crude Oil Weekly $73.75 call options expiring next Friday. Liquidity providers immediately respond with a two-sided market, with 96% of all Request-for-Quote in WTI Crude Weeklies receiving a response within one second.

The trader lifts the offer and is now long the $73.75 call options. If futures prices move lower, his portfolio will benefit, but if futures prices move higher, his Weekly call options hedge will pay off.  

Results

There were no announcements adjusting production from oil-producing nations over the weekend or early in the week. However, news outlets continued to report that production cuts were still a possibility. 

Futures prices remained stable going into the week, but the trader’s portfolio risk remained over the next weekend and following week. The trader needs to protect his portfolio again for another five to seven calendar days.

To do so, the trader sends another RFQ to CME Globex for a horizontal call spread where he’s selling his hedge of the current Friday $73.75 call and buying next Friday’s $73.75 call. This allows him to roll his hedge forward while remaining protected against a move higher in futures prices.

As expected, Crude Oil futures prices rallied on the back of production cuts. By the Weekly options expiration on Friday, futures prices had traded through the $73.75 strike price and settled at $74.00, resulting in the $73.75 calls expiring in-the-money. 

Because Crude Oil Weekly options do not allow contrary instructions, the trader knew his exact resulting long futures position and incorporated that hedge into his portfolio.  

Conclusion

The trader identified a short-term risk to his portfolio and used Crude Oil Weekly options as a precise low premium hedge. The trader needed to extend the time horizon on his hedge and was easily able to roll his Weekly call option forward to the following week.

Market-moving events such as OPEC announcements, EIA inventory data, and geopolitical incidents can significantly impact volatility in crude oil markets. WTI Weekly options provide a deep pool of liquidity for market participants to not only express their views on market-moving events but also manage the volatility associated with them. 

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