After a period of relative stability in the oil market where U.S. crude benchmark WTI was trading above $70 a barrel for more than a month, traders are now bracing for a wild ride for the rest of the summer.
Traders in the crude oil options market expect volatility to spike in the coming weeks and are hedging more against further price declines, data compiled by The Wall Street Journal showed. The increased caution suggests that market participants are weighing the prospect of rising oil supply from OPEC+ in the coming months against concerns about potential stalling of the global oil demand recovery amid the spike in COVID cases in many countries.
Market participants have come to realize that the rebound in oil demand this summer will not shoot oil prices up to $100 a barrel and that flare-ups in virus cases here and there would inevitably hit market sentiment.
“It’s going to be a lot more turbulent than people expected,” Marwan Younes, chief investment officer at commodity-focused hedge fund Massar Capital Management, told the Journal.
It was indeed turbulent at the start of this week in the oil market.
OPEC+ finally announced on Sunday a deal on how it would ease the production cuts. But the market focused on Monday on fears of demand recovery amid surging Delta variant infections in a broader sell-off in equity markets and a generally risk-averse trading approach. Risk aversion hit oil and lifted the U.S. dollar. The stronger dollar additionally weighed on oil prices on Monday.
As a result, WTI Crude prices plunged by 7 percent, the biggest one-day loss so far this year and the largest such loss since September 2020. The market started to fret about what the rising Delta variant infections would mean for economies and the oil demand recovery. If countries, especially those in Asia where vaccination rates are generally lower, were to impose restrictions on mobility again, this would reduce fuel demand.
So, volatility in the oil market spiked again, and a measure of implied volatility over the next month based on option contract prices jumped to 41.2 percent on Monday, according to data from QuikStrike cited by the Journal.
Sure, few market participants expect a repeat of the April 2020 volatility, when U.S. oil prices turned negative for a day. OPEC+ took care of that by sealing a deal—even if it took it two weeks—to reassure the market that there would not be a new price war coming soon.
Nevertheless, traders are hedging more against oil price slides via the so-called risk reversal strategy to protect their bullish call options with bearish put options, the QuikStrike data cited by the WSJ showed.
The market and most analysts generally believe that the OPEC+ agreement is constructive for oil prices as it removes the possibility—even if it was a remote one—of a renewed price war. But participants continue to be tuned to bearish news in the summer lull period, which, with lower liquidity, leads to higher volatility in markets.
The OPEC+ agreement “has provided more certainty for the market, and so in theory should reduce volatility. However, clearly this week, macro and demand concerns have overshadowed supply developments,” ING strategists Warren Patterson and Wenyu Yao said early on Wednesday.
The Delta variant surge in many countries—including in those with high vaccination rates such as the United States and the UK—and the jitters it caused on all global markets on Monday highlights the challenges traders face in betting on oil now.
Many analysts believe oil prices are set to return to above $70, with Goldman Sachs even expecting $80 oil, but oil option traders are getting ready for more volatility and wild price swings ahead.