Managing Oil Price Uncertainty with Micro WTI StraddlesYou cannot predict the future, but you can prepare for it. This is even more true for crude oil prices. Forces driving and pulling back oil prices are in full play in parallel at the same time. Oil prices remain at the risk to both the upside and the downside concurrently.
Take this week as an example. WTI prices started with a rally extending a three-day uptrend of >7% following Fed’s hint at rate cuts plus heightened tensions between Israel and Hezbollah. The rally reversed as tensions eased. Crude oil prices crashed 3.8% over Tuesday & Wednesday on fears of feeble demand.
RATE CUTS AND GEOPOLITICAL TENSIONS DRIVE OIL PRICES HIGHER
The US Federal Reserve Chair Jerome Powell has signalled that the time to pivot was about now when speaking at the Jackson Hole Symposium last week on 23/Aug. This boosted optimism for oil prices, fuelling a rally reversing a price slump caused by weak Chinese economic data and disappointing US payroll revisions.
Chair Powell’s remarks lifted market sentiment, leading to gains in oil prices and the dollar weakening. A feeble dollar makes oil cheaper for non US consumers and can help increase demand pushing up oil prices.
Source: CME FedWatch Tool
According to CME’s FedWatch tool , there is a 67.5% likelihood of a 25 basis points (“bps”) rate cut and a 32.5% chance of a 50 bps rate reduction at the September FOMC meeting.
Sadly, the tensions in the Middle East continue to prevail. Last weekend, Hezbollah launched rockets and drones into Israel, prompting a swift response from Israel's military, which deployed around 100 jets to prevent a larger attack.
Adding to these factors are disruptions in oil production in Libya and Colombia.
The easing of tensions between Hezbollah and Israel reduced supply fears, with some speculating that Iran might view Hezbollah's missile attacks as sufficient retaliation.
Despite easing tensions, supply concerns persist in Libya threatening to reduce oil production by 1.2m bpd.
WEAKENING DEMAND AND OVER PRODUCTION COULD PULL OIL PRICES BACK
Concerns over weak oil demand from China, a global economic slowdown on the horizon, and elevated Russian crude production is keeping oil prices under check.
Russia has exceeded its OPEC+ production targets since March, leading to excess supply that is undermining the impact of OPEC+ production cuts and keeping prices low.
Source: OPEC and IEA
On Wednesday, the EIA reported a decline of 846,000 barrels in US crude inventories for the week ending 23/Aug, falling short of analyst expectations of a 2.7 million barrel drawdown. The market response to this smaller-than-expected inventory decrease was muted.
Demand for crude and gasoline will soften as US summer driving season ends first week of September.
Expectations of weaker US gasoline demand and lower refining margins have led several refiners to scale down their operations reducing demand for crude.
The largest US refiner, Marathon Petroleum ( NYSE:MPC ), announced that it will reduce its refining capacity to 90% this quarter, the lowest for a Q3 since 2020. PBF Energy ( NYSE:PBF ) will lower its capacity utilization to a three-year low, and Phillips 66 ( NYSE:PSX ) will cut its capacity to a two-year low.
Goldman Sachs and Morgan Stanley reduced their 2025 Brent crude forecast to USD 77/barrel and USD 75/barrel respectively. Reasons cited for reducing forecasts include weaker Chinese demand, higher inventories, oversupply from OPEC countries, and rising US shale production for the downward revision.
HYPOTHETICAL TRADE SETUP
Over the past two weeks, crude oil prices have been volatile for reasons mentioned above. Looking ahead, rate cuts in September, the ongoing crisis in Libya, and reduced US gasoline demand will fuel further uncertainty to oil prices in the near term.
This is evident from rising WTI crude oil implied volatility. Earlier on 05/Aug it slid from its YTD high of 44.7 but has started to pick up again.
Source: CME CVOL
Establishing a directional position amid such uncertain backdrop is rife with risks. Long straddles using Micro WTI Crude Oil Options offer an effective way to capitalize on rising volatility.
Straddles are designed to benefit from (a) significant price movements in the underlying asset regardless of the price move and (b) volatility spikes. Sharp oil price moves, and volatility spike are to be expected given the current context.
Straddles provides “unlimited” profit potential combined with limited downside risk. A straddle comprises of two trade legs, namely, a long ATM call option combined with a long ATM put option.
This paper posits a long straddle on CME Micro WTI options expiring on 17th September. Micro WTI options provide exposure to 100 barrels of WTI crude offering a smaller contract size and lower premium requirements.
Based on 30/August market prices, this hypothetical trade set-up uses CME Micro WTI Crude Oil options expiring on 17th September and involves (a) Buying a 76 ATM Call, and (b) Buying a 76 ATM Put.
The premiums for each leg and the corresponding option Greeks as shown QuikStrike Strategy Simulator are shown below for ease of reference.
The straddle requires USD 1.91 per barrel in premium for the long call and USD 1.8 per barrel for the long put. In aggregate the straddle would cost USD 3.71 a barrel. Each CME Micro WTI Crude Oil option comprises 100 barrels which translates to a premium of USD 371 per lot.
When Micro WTI Crude Oil futures trade past break-even points as shown in the chart, this straddle will deliver positive returns.
• Lower break-even point: 76 - 3.71 = 72.29
• Upper break-even point: 76 + 3.71 = 79.71
However, at expiry, if Micro WTI Crude Oil Futures prices settle between USD 72.29 and USD 79.71 a barrel, this straddle will incur a maximum loss of USD 3.71/barrel or USD 371/lot.
The straddle pay-off are summarized in the table below to augment the above chart, illustrating the potential P/L of this trade at a few settlement prices.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
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This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
MCL1!
Oil crushing it's slippery slope NYMEX:MCL1!
After nearly a month of selling, oil seems to be taking back buyer's momentum that first started on July 17th, 2024 and ended on August 6th, 2024. When the creation of the "W" formed shortly after hitting a 10 min supply area, this signaled the last moments of Oil's sell trend. As we go into this week, we see that oil is still coming in hot to take back supply area's that it created on the 1hr timeframe, but it's due for a pullback. Depending on after market movements, we can possibly see Oil start to pullback to continue making buy structure to the upside. Oil has a good possibility to make it back to the areas of 83.50 and 84.50. Since in current time right now as I'm typing this, Oil has already broken 3 LH's (lower high) that were created between July 22nd, 2024 and August 1st, 2024. We can see pullbacks in the range of 78.84 and 77.12 to potentially see continuation of buying movements. Within this outlook, my current analysis is buyers market until price shows other signs.
Oil Set to Re-test $82.71 Amidst Market ConsolidationOil prices are currently in a consolidation phase and are expected to test the $82.71 level by the London session.
This price action suggests a continuation of the uptrend. For those already in the market, it's advisable to seek sell opportunities in line with your trading strategy. For instance, if you trade using Supply and Demand principles, identify supply zones towards $82.71.
Once the market tests this zone and it holds, look for buy signals as confirmation of the continuing uptrend.
Oil recently hit a fresh two-month high, driven by mounting geopolitical risks in Europe and the Middle East, as well as the threat of a hurricane in the Caribbean. With these factors in play, a significant drop in prices is unlikely.
Therefore, it's crucial to monitor for sell setups towards this re-test zone and then prepare to capitalize on the anticipated upward momentum. There is potential to capture substantial moves towards the upside.
Shrinking Inventories Lends Support to Oil PricesCrude oil prices have remained lacklustre and rangebound in 2024. Slow economic growth and abundant production have kept prices muted. OPEC's efforts of supply cuts haven’t helped. Neither have geopolitical tensions.
Over the past two weeks, oil prices have once more started to pick up steam, supported by trend of shrinking inventory. Despite the price buoyancy, we expect prices to remain rangebound with supply and demand in balance.
Yet even during these periods, positioning tactically can allow traders to harness positive gains. This paper posits a calendar spread in CME Crude Oil futures which provides a reward to risk ratio of 1.3x while remaining directionally neutral.
PERSISTENT GEOPOLITICAL RISKS FAIL TO INFLUENCE PRICES
While price, the options skew and IV may not reflect it, geo-political risk for oil supply has not dissipated. Geopolitics remains tense with the conflict in Ukraine and the middle east showing no signs of ending anytime soon. Cease-fire negotiations are stuck in a stalemate. Houthi rebels continue to target ships passing through the Red Sea.
Conflicts are dragging on. The risk of escalation remains high.
Earlier this year, Ukrainian drone attacks on Russian refineries reportedly destroyed approximately 12% of Russia’s total oil processing capacity. According to analysts , continued disruptions and attacks on Russian oil infrastructure is likely to pressure Russian production and exports.
Confluence of these risk factors suggests the potential for upside risk in oil prices. Yet, IV does not reflect this sentiment. CVOL index for CME Crude Oil options is at a four-year low and skew is close to zero suggesting demand for call options remains subdued.
Source - CME CVOL
It is difficult to establish a directional stance based on geopolitical risks given the fragile situation.
REOPENING REFINERIES PROVIDE MUCH NEEDED CRUDE DEMAND
Towards the end of January, a divergence in crude inventories & gasoline stockpiles started to emerge. US crude inventories saw large buildups while refined oil inventories had large drawdowns.
This suggested that while demand for crude products was strong, seasonal refinery outages meant demand for crude oil was subdued. The refinery outages were exacerbated by the cold blast in January which led to unplanned shutdowns. The impact – excessive buildup of crude inventories which led to bearish prices.
At the same time, inventories of refined crude products like gasoline showed that demand at the downstream has remained strong. Gasoline inventories have fallen sharply over the past month and stand near their 5-year lows.
Data Source - EIA
Over the past month, though, refineries have come back online much faster than anticipated. Refinery utilization rate has surged from 80% in early Feb to almost 88% as of 15/March.
Data Source - EIA
Increase in refinery utilization has provided much needed demand for crude oil. Crude oil inventories have shifted from their huge buildups to drawdowns over the past week.
At the same time, gasoline inventories continue to decline at a rapid pace suggesting strong fuel demand.
Data Source - EIA
In EIA’s weekly petroleum status report for the week ending 15/March, crude inventories fell more than expected (2 million barrels vs 900k barrels expected). The reason for the surprise – higher exports and refinery activity. This suggests that the demand for crude oil in the near term is stronger than many expected after the huge buildups in Feb.
OPEC+ SUPPLY CUT EXTENSION FAILS TO ENTHUSE MARKETS
At the meeting on 3/March, OPEC announced the extension of their voluntary production cuts till June. Cuts remain at around 2 million bpd, unchanged from previous guidance set in November 2023.
Despite the extension of cuts, crude prices remained muted. According to S&P Global , many participants were already expecting the extension.
Source - OPEC Monthly Report
Moreover, the recent non-compliance of production quotas by some members has become a major concern. In January, OPEC members exceeded their quota by 139k bpd. In February, members exceeded their quotas by 208k bpd.
Source - OPEC Monthly Report
Most of the non-compliance is coming from a select few nations - Iraq, Kazakhstan, Kuwait, the UAE, and Gabon.
Source - OPEC Monthly Report
Over-production raises concerns over seriousness to production cut commitments and its long-term sustainability. It is likely that over-production and the eventual roll-back of supply cuts will lead to a higher supply of crude oil later in the year.
HYPOTHETICAL TRADE SET UP
In the near term, crude inventories are likely to see increasing drawdowns given the rapid ramp-up of refineries and persistently high fuel demand. Outages in Russia are also impacting near-term supply on a global scale.
Yet the supply outlook later in the year is less promising. The compliance of OPEC+ supply cuts are fading. Seasonal trends show that crude inventories tend to rise during the summer.
Data Source - EIA
Investors can take advantage of these trends by executing a calendar spread consisting of a long position on near term CME WTI Crude Oil Futures and a short position on a later expiry.
Though, the backwardation on crude oil has become steeper over the past month, it potentially has scope to steepen further.
The following hypothetical trade comprising a long position on the near-dated contract expiring in April (MCLK2024) and a short position on the further dated contract expiring in May (MCLM2024) provides a compelling reward-to-risk ratio of 1.4x.
A calendar spread using WTI Light Sweet Crude Oil Futures is directionally neutral. It is also beneficial from a margin standpoint. CME offers margin offsets for calendar spreads due to its relative lower risk profile of the trade. The spread requires maintenance margin of just USD 40.
• Entry: 1.0063
• Target: 1.0135
• Stop Loss: 1.0003
• Profit at Target: USD 57.8
• Loss at Stop: USD 48.6
• Reward to Risk: 1.2x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Closed (Margin): /MCL August 17th 59/88 Short Strangle... for a 1.31 debit.
Comments: Took this off earlier in the day, mixing and matching profitable call with profitable put from strangles I put on over time ... . Net 4.11 credits collected at this point, leaving me with the 58P/60.5P/85.5C/89.5C. With the entire position marking at 3.25, so I'm up .86 ($86) at this point.
Opening (Margin): /MCL August 17th 58/85.5 Short Strangle... for a 1.58 credit.
Comments: An additive delta adjustment trade, selling the -16 delta call and the +10 delta put to pick up -6 of net delta.
1.58 credit on buying power of 4.48.
Total credits collected to date: 5.42.
Entire Position:
58P/59P/60.5P/85.5C/88C/89.5C
Closing (Margin): /MCL August 58/89 Short Strangle... for a 1.29 debit.
Comments: Mixing and matching profitable call with profitable put from short strangles I erected over time. 3.84 net credits received to date, leaving me with the 59P/60.5P/88C/89.5C.
I may go ahead and sell a new short strangle in August to delta balance the entire position back to net delta flat here.
Opening (Margin): /MCL August 17th 60.50/89 Short Strangle... for a 1.77 credit.
Comments: Selling the +14 delta put and the -12 delta call here as an additive delta adjustment trade to bring the entire position back to net delta flat.
Entire Position: 58P/59P/60.5P/88C/89C/89.5C
Total Credits Received: 5.13
Closing (Margin): /MCL August 17th 55.5/93 Short Strangle... for a 1.02 debit.
Comments: Mixing and matching profitable short call with profitable short put from the /MCL short strangles I put on in August (See Posts Below).
This leaves me with the 58P/59P/88C/89.5C with a cost basis of 4.38 - 1.02 or 3.36.
Opening (Margin): /MCL August 17th 55.5/89.5 Short Strangle... for a 1.39 credit.
Comments: Selling the 10 delta's here both sides. Will look to manage sides on approaching worthless or on side test.
1.39 on buying power effect of 3.51; 39.6% ROC as a function of buying power effect at max; 19.8% at 50% max.
Opening (Margin): /MCL June 14th 55/93 Short Strangle... for a 1.37/contract credit.
Comments: Selling 10 delta on each side. 1.37 credit on buying power effect of around 3.54/contract. 38.7% ROC at max as a function of buying power effect; 19.4% at 50% max. Will generally leave the setup alone, adjusting only on side test or side approaching worthless. While I like to generally hang out for 50% max, I won't hesitate to money, take, run if I get tired of looking at the setup (lol), particularly since I've gone longer-dated than usual here (77 days 'til expiry).
Opening (Margin): /MCL May 17th 56.5/92.25 Short Strangle... for a 1.34/contract credit.
Comments: Going wide, nondirectional here, looking to generate around a 25% ROC as a function of buying power effect, so ended up selling the 10 delta on both sides. 1.34 on buying power effect of 4.50; 29.8% ROC at max as a function of buying power effect; 14.9% at 50% max. Will generally look to leave the setup alone, adjusting only on side test or side approaching worthless.
Opening (Margin): /MCL April 17th 78.25 Short Straddle... for a 7.66 credit.
Comments: Re-establishing here with 47 days in the April monthly to go ... . As before, will primarily make additive adjustments to get to the size of position I want and then look to just rolling sides in for adjustments without adding units.
Opening (Margin): /MCL April 17th 76 Short Straddle... for an 8.01 credit.
Comments: Re-establishing in the April monthly with 49 days to go. 8.01 credit on buying power effect of 8.87. 90.3% ROC as a function of buying power effect at max; 22.6% at 25% max. 67.99/84.01 break evens.
As before, will look to add until I get to the size of position I'm comfortable with, then do additive, subtractive, and rolling adjustments to keep the position from getting too directional.
Opening (Margin): /MCL March 16th 78 Short Straddle... for a 7.10 credit.
Comments: I still have a little bit of time in this cycle (35 DTE) to putz around with reverse gamma scalping /MCL, so putting on a fresh short straddle at the 78 strike for the starter position. Will generally look to make additive adjustments to keep the delta/theta ratio <1.0 right up until 21 DTE, at which time I'll take the whole pile of pasta off.
Current break evens for the setup are 70.90 on the put side, 85.10 on the call. 7.10 credit on buying power effect of 9.88, 71.8% return on capital as a function of buying power at max, 18.0% at 25% max.*
* -- Generally, I look to take profit on short straddles at 25% of max.
Opening (Margin): /MCL March 16th 79.25 Short Straddle... for a 9.19 credit.
Comments: A short delta additive adjustment trade here to cut net long delta in my entire /MCL position by about half, with the goal being to keep the delta/theta ratio under 1.0. The entire position still leans net long, but I will leave it that way to see if the market does some of the lifting for me.
Total credits collected of 13.90. As with my /MES reverse gamma scalping setup, looking to take about 25% of total credits received out of the position, closing it out in its entirety at no later than about half way through the cycle (i.e., around 21 DTE) before moving on to the next monthly.
For those of you just tuning in: This is not a standalone trade. It is an adjustment to an existing position with delta/theta metrics peculiar to that position. Unless you have that exact same position on with the exact same delta/theta metrics, this trade will only be informational or educational as to how to make an additive delta adjustment to a position you currently have on, particularly using a skewed short straddle to accomplish the task. I would note that this isn't the only way in which to adjust position net delta; it is just the tool I am using in this particular case.
The entire position is also nondirectional by nature with the sole effort being to keep the net position's zero delta/gamma point within shouting distance of current price with various delta adjustments, some of which will be additive (adding contracts), some of which will be subtractive (closing out contracts). I have no opinion as to where oil goes from here or how much it will move in any given day or over a given time frame or whether a particular level is important or not for price action purposes. This type of setup is basically a bet that the underlying stays within the expected move (EM) or some factor of the expected move as determined by options delta and little else.
Opening (Margin): /MCL March 16th 70*/101 Short Strangle... for a 1.33 credit.
Comments: An additive delta adjustment trade, selling the +13 delta put at the 70 and the -8 delta call at the 101. The position still leans net delta short here, which I'm fine with since WTI is toward the top of its 30-day range.
* -- The 70 is shown at the 69 strike.
Closing (Margin): /MCL 69/96 Short Strangle... for a 1.68 debit.
Comments: Received 2.00 in credits for this pair of legs. Closing out here for 1.68 as a profitable, subtractive delta adjustment trade. .32 ($32.00) profit. This leaves me (at the moment) with a 10 delta short strangle at the 66/97 and a 17 delta short strangle at the 70.5/93, with the entire position being net delta flat.