Excell with Options: Three-Pronged Approach to Analyzing the Crude Oil Market

When I am trying to get a sense of direction in an individual asset or a market overall, I go to a three-pronged approach to assessment. The three areas I look at are the fundamentals (i.e., what drives that market or security, what is the trend), the behavioral (i.e., how are investors positioned, what is priced into the security, what do the bulls and bears think) and the catalyst (i.e., what will get either bulls or bears to change their minds).  I feel that when I have all three of these leaning toward a particular position, it is an opportunity to have a full-sized position. If a couple of them cancel out, and one is neutral, it might be better to sit on the sidelines. There are many other iterations in between. However, the discipline of this approach has served me well. 

When I looked at Oil markets this week, I knew the first chart I would want to understand is the supply and demand of oil as determined by the U.S. Department of Energy’s Energy Information Agency (EIA). The EIA makes a monthly determination of global demand and supply. I have found that when I look at this number, I tend to draw in bands at +/- 1.5 million barrels per day. These levels are one  indication I use to determine if a market is over or under supplied. I show the period in 2021, which I circled, where demand was more than 1.5 mb/d above supply. I can see over this period it was bullish for oil. Similarly, I can see from middle of 2022 to early 2023 there was supply that was more than 1.5mb/d than demand, so this was similarly bearish. When the differential has fallen within this band, there is neither a bullish or bearish signal as there is now and has been for some time.