Anyone following the oil market even just casually will know that oil prices have been under some pressure the last couple of months. While there are recession fears rippling through many markets, a big driving force in oil markets is the increase in supply from OPEC+. After all, coming into 2025, oil markets still had “drill, baby, drill” in their minds when it came to U.S. supply. In the last few months, OPEC+ has agreed to accelerated oil output, unwinding output cuts that were announced in December of last year. The increases in production will unwind 44% of the cuts announced in December and could continue to pressure prices. OPEC+ suggests that demand is strong enough to handle the increase in supply; however, commodity traders worried about a recession may not agree with OPEC+ ministers.

While OPEC+ produces neither Brent nor WTI crude, its members produce crude oil types that are more similar to Brent than WTI, so announcements may impact Brent more directly. The spread between Brent and WTI in dollar terms is about 1 standard deviation tighter than the mean over the last several years. If the spread stays reasonably consistent in the $3 – $4 range, with pressure on Brent, we could expect WTI futures to feel continued downward pressure even with price sub $60 already.

Using a chart I have shown before, I look at the difference between oil consumption and oil supply per the EIA and show that when supply and demand get out of balance by more than 1%, we see an impact on futures prices. For instance, in the 2020 – 2021 period, you can see that consumption outstripped supply by more than 1% per day which led to a consistent upward pressure on prices. However, in the late 2022 – early 2023 period, particularly with the U.S. government draining the Strategic Petroleum Reserve, supply outstripped consumption by more than 1% (as much as 3% actually) which pressured futures prices lower. Over the last 2 years, consumption and supply has stayed pretty constant, which has led to rangebound prices, until very recently. With the latest supply increases, especially if recession becomes more of a reality, could oil prices be set for a new trend lower?

Turning to trader positioning, we can see in the Commitment of Traders report that while managed money is long WTI futures, it is below the average for the last three years. The length was lower earlier this year, and recently traders have slightly added to the length. There is no real strong sign that trader positioning will be a particularly large catalyst, and if anything, managed money appears to be slowing the pace of the move lower at this point.

Volatility markets may be anticipating a further move lower, however. In the top chart, we can see that volatility, as measured by the CVOL index, has trended lower over the last few years. However, in the last 6 months, and particularly in the last month, volatility has shot higher and now stands near the highs of the last three years. There also does not seem to be a particularly strong correlation between the direction of the underlying and the overall level of volatility. There does seem to be a correlation, though, between the direction of the underlying and the Skew Ratio. The Skew Ratio measures the relative demand for downside strikes vs. upside strikes, between puts and calls, and as prices move lower, the demand for downside picks up. That is certainly the case right now, with the Skew Ratio at the lowest levels of the last three years suggesting options traders are seeing good demand overall for options (CVOL near three-year highs) and that demand is coming more from the downside options (Skew Ratio at three-year lows). Options traders appear to be betting on a further decline in futures prices.

It is not surprising to see demand for downside options when you turn to the technical charts. The top chart has the daily Ichimoku cloud chart, and it is quite bearish. Prices and the lagging span have broken below the cloud and continue to head lower. The cloud itself is heading lower indicating the downward trend is beginning. The MACD has crossed to the downside and looks set to move lower and the RSI is not showing signs of being oversold yet. The weekly chart does not give much hope for prices either. While the longer-term trend is not as clear yet, prices and lagging span are below the cloud and the MACD is headed lower indicating even over the medium term, prices are under pressure.

All signs appear to be pointing lower for WTI futures. Supply looks set to continue. There are concerns about demand because of the potential of a recession. Options traders are gearing up for a move lower and the technical charts, both daily and weekly, point to lower prices. The only small positive is that managed money has been increasing its length, potentially slowing the pace of a move lower. With volatility high, especially for downside options given the increased relative demand, bearish spreads that buy options are unappealing. However, as we move into less charted territory, selling options can seem risky to many traders. As a result, I would suggest traders consider a put butterfly, which takes advantage of the higher volatility for downside strikes but does so in a fixed risk/defined payout fashion. It is also short delta and bearish from the onset, allowing traders to express the downside view. I have the strikes offset in case prices continue to break lower and move through the lowest strike, ensuring some profitability if the move is larger than expected. The main contrarian view in this spread is the pace of the move, as the implementation of the idea suggests the pace of the move will be lower but quite gradual as much of the negative news is priced in. I have used the ML3K5 expiration which is a Monday expiry in about 2 weeks. With daily expirations in WTI options, traders have the flexibility to customize the date of their trade to precisely the next expected catalyst. I have chosen the Monday because I am short options in this spread on net, and I am hoping we drift to strike and sit near the strike right before expiration. This would maximize the time decay I earn over a weekend where there are no catalysts. The idea in this spread is that all of the news and all of the catalysts have come out, however, there still may be a drift lower given the setup. This drift may lose some pace, so the butterfly allows me to capture both the drift and the lack of volatility the market is expecting.

The tools to analyze the market dynamics and the flexibility of daily expirations give traders the ability to implement ideas that most closely resemble the directional, volatility and time view they have. Stay vigilant and good luck trading!

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