There has been a good deal of disagreement between the spot/physical oil trades and the Oil futures traders particularly when it comes not about the current level of front-month Crude, but about the shape of the futures curve? This was made evident in comments by the CEO of Saudi Aramco that were picked up in a Bloomberg news story. As you can see in snippets taken from the article, the CEO Amin Nasser sees global oil markets losing 100 million barrels every week the Strait of Hormuz is shut, compounding a supply shortage. He says this is not being felt in futures markets right now because companies and governments are dipping into storage, but stockpiles are running low. Finally, Nasser sees a disconnect between prices trading in futures markets with physical barrels. This message is one that many physical market traders and analysts have been saying but has been downplayed or even ignored by others in the market. 

Looking at the latest readings of oil supply and consumption from the EIA at the U.S. Department of Energy, we see that world oil consumption has recently dipped from 106 million barrels at the start of the year to 102 barrels in the latest reading. Supply has fallen even more sharply. At the start of the year, oil supply was 109 million barrels and many in the market discussed how the oil market was oversupplied, and had been since early 2025, which is why futures prices had fallen from over $70 a barrel to under $60 a barrel by the end of 2025. With supply shut in by the Middle East conflict, however, since the beginning of March world oil supply fell from 108 million barrels to just 98 million barrels in the latest reading. Now the world is worried about under supply with those 4 million barrels a day equating to 25 – 30 million a week, still far less than the 100 million per week that Saudi Aramco is discussing. Could the situation of oil supply and demand get even worse than we have seen it?

In spite of warnings that this supply/demand situation is not going to improve any time soon, the Oil futures curve shows signs that it expects normalization. This is not expected in the short term, but the futures market sees oil dropping from $98 currently to $80 by the end of 2026 and $73 by the end of 2027. This is not the shape of a curve one would expect if supply disruptions were expected for the foreseeable future, much less if the supply situation was expected to get worse as Saudi Aramco suggests. Perhaps the futures traders are seeing a different picture for supply and demand. Maybe there is new supply expected from places like Venezuela, Russia or U.S. energy producers are expected to increase output. Another view could be that this level of oil price is going to slow demand such that supply and demand will be back in balance, but just at a much lower level than the 106 – 108 million barrels seen at the end of 2025 and early 2026. 

Turning to technical analysis, we see that after the spike to $115 dollars in front-month Crude in early March and again in early April, futures prices pulled back and twice tested the $90 region. On each pullback, prices held support. While the market did get very overbought in early March, the wide but sideways price action between $90 and 110 over the past two months has worked off any overbought readings and the RSI is solidly in the middle of the range. Finally, the MACD is not giving any indication of a near-term move but pointing to the same consolidation we see in both the Ichimoku cloud and the RSI. Overall, the chart looks neutral to slightly positive but no imminently actionable items.

Now looking at the volatility markets, we see the same levels of neutral to positive action with a consolidation currently underway. The CVOL Index of volatility spiked with futures prices in March to the highest levels in 3 years. It has since pulled back but is still higher than even the spike last summer. In general, the pattern of CVOL looks very similar to the price of oil, suggesting positive co-movement if not positive correlation. The bottom chart shows that the nervous side of the market is the upside in oil with skew ratio – a ratio of upside variance to downside variance – moving higher on higher prices and back lower with lower prices. As price consolidates at the highest levels of the past 3 years, the skew ratio settled in around 1.5, a level we have touched many times the past few years, but which never holds for very long. After getting above 1.75, 1.5 may look like a new low level after previously being a new high. Both charts indicate that higher Oil prices should see higher CVOL and more demand for upside options relative to downside options. 

Now that we have a general sense of what implied volatility and calls versus puts should do based on movements, it is time to try and pick the right expiration and the right strikes. In order to pick the right expiration, we like to use the implied volatility term structure which shows the relative pricing of each expiration. Since we are looking at a medium- to long-term supply disruption, we need to move out beyond the front part of the vol curve more to the middle part of the curve. As you see, and perhaps not surprisingly, as the Oil futures curve starts to normalize over the course of 2026, the implied volatility curve does the same. While the front part of the curve is in the 70 – 75 vol range, by the end of 2026, it is quickly back to the low 40s. That is an incredibly steep curve but one that may present an opportunity for traders, especially traders who are bullish. If we know that bullish Oil has meant higher volatility, and we look further out on the curve and see both lower Oil prices and lower volatility, this could be a golden opportunity. Zeroing in on the particular expiration in the bottom chart, we see the biggest dropoff happening in Q4, as implied volatility drops from 58 – 52 to 49 – 45. The lowest number is the December contract, but the most interesting contract may be the November expiration which runs off in the run-up to the midterm U.S. elections. As affordability has been a big issue for years, one might think the administration will be doing all it can to get oil lower. If it is unable to do so, it is easier to see the potential for a lot more volatility than may be priced in.

Putting all of this information together, it is time to create the trade. The commentary from the physical market suggests that a supply shortage could continue to be a driver of higher prices throughout 2026. The futures market may not fully price in this impact according to industry management teams. The technical charts point to some near-term consolidation before the continuation of a bullish trend. The implied volatility markets are high right now but taper off quite considerably toward the end of the year. Thus, if we want to buy any options, even as part of a spread, it may be more fortuitous to do it later in the year, which also gives the idea some time to play out. There could be an interest to pressure oil prices lower into the U.S. midterm election, but given governments – especially the U.S. – are using the Strategic Petroleum Reserve now, the tools at their disposal may be limited. This all makes me bullish, but more bullish in the back end of the curve than the front end of the curve. Higher volatility levels in general lead me to consider a spread versus outright options, because even if the curve is downward sloping, backend vol levels are still high and the CVOL suggests any normalization could see quite the dropoff. 

This leads me to consider a Christmas tree spread. This isn’t because I am looking at November options and getting in the holiday spirit. The Christmas tree is a low premium, high reward-to-risk spread that is similar to a call butterfly in that there are the same number of strikes bought and sold, but it is different because we buy 1 nearer the money, sell 3 in the middle and then buy 2 strikes higher. In addition, the strikes are typically asymmetrical as well. This enables us to keep the premium very low. In the case of the strikes I chose, it is a zero-premium trade. This means if the bullish move never happens, I am not out any money. This is as close to a set-it-and-forget-it bullish trade as I can find. 

Of course, it isn’t without risk. Since we sell more of the middle strike and the strikes are asymmetrical, if Oil blows through the upper strike, we will lose money. However, this risk is capped so we know what that risk is at the time of trade. We need to settle as close to the middle strike as possible to maximize the return. 

I have chosen the November expiration 90-95-98 call Christmas tree. It costs zero at the time of trade. The maximum return is 5 at the 95 strike at expiration. The maximum loss is 1 if we are 98 or higher at expiration so basically current spot levels or higher. The current future for that expiration is 82 so this gives 20% of backend upside before losses would happen at expiration. You can see from the flat lines before the expiration payout that there is very little mark-to-market risk on this trade and all of the action happens in the last month of the life of the spread. That means there is not much to do over the next several months but observe how the supply and demand situation in oil develops. If more supply is found and prices look to stay lower, there is little a trader needs to do because you spend no money on the trade. The risk management comes if there really is a supply disruption and the top side strike is in play. A trader can look to roll their strikes at that time, and since there is little mark to market in the next few months, it should not be costly to do so. 

Having the ability to analyze the term structure of both the futures and options market, in order to find the best expression of an idea – whether bullish or bearish futures or volatility – is an important strength of the CME Group platform. Multiple products to trade with multiple tools to analyze and risk-manage is a trader’s dream come true. 

Good luck trading!

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