| NEW YORK
NEW YORK Dec 8 Oil traders who bought U.S.
crude call options before OPEC's agreement last week to cut
output did not get the windfall they were expecting as the rally
in those options fell short of crude's massive surge.
Early last week ahead of the Organization of Petroleum
Exporting Countries meeting, traders piled into inexpensive West
Texas Intermediate January $60 calls expiring in
mid-December with premiums between 6 to 8 cents. The buying
pumped open interest up by about 90,000 lots in just three days
to a record for that contract.
Call options confer the right to buy a futures contract at a
preset price and date. While they tend to rise in value when the
underlying contract goes up, the point of the trade was not
necessarily to get oil prices up past $60 a barrel, but to sell
when premiums rose if oil, as predicted, surged.
Oil indeed jumped after OPEC agreed to cut output - rising
by nearly $5 a barrel, or more than 10 percent on Wednesday,
after OPEC agreed to cut production - but options premiums rose
by only 3 cents day-over-day. That made the trade profitable,
just not as lucrative as expected.
"At the end of the day, the risk (in these options) is
defined and limited. It's either going to work out in a big way
or fizzle out," said John Saucer, vice president of research and
analytics at Mobius Risk Group in Houston.
The culprit was implied volatility, a determinant of an
option's premium, for January. Volatility for at the money
options fell 29 percentage points in the latter half
of the week, resulting in the biggest weekly decline since
January 2009, according to Thomson Reuters data.
That's what kept the premium - the cost of the option - from
rising commensurate with the move in futures, as fewer people
jumped in to bet that oil would hit $60 by the mid-December
Implied volatility was expected to decline, as it generally
moves inversely to prices. But the sharp dip came because
producers responded to the rally by using complex hedging
structures that weighed on volatility, said Harry
Tchilinguirian, global head of commodity markets strategy at BNP
"We saw a lot more three-way structures used by producers"
to hedge 2017 and 2018 production, he said. "These kind of
producer hedges are net short volatility overall."
In a three-way structure, a producer buys a put - an option
protecting from price declines - close to the at-the-money level
and sells a lower-strike put. They also sell an out-of-the-money
call, which limits upside. It's essentially a bet on stability,
and the buying of one option while selling two is negative for
Implied volatility for the WTI 25-delta put with a one-month
expiration rallied to a eight-month high on Nov. 30
to 57.57 percent, but plunged to 43.16 percent the next day and
below 37 percent by Dec. 2. The implied volatility for the
corresponding call touched a nine-month high of
52.08 percent, but then slumped to 33 percent by Dec. 2.
Dealers said there was also active buying of one-by-two call
spreads, which involve buying at-the-money calls and selling two
lower-delta calls further out of the money. Like the three-way
structures, that involves more selling of options than buying,
which also lowers volatility.
Three trade sources said that one large fund bought 50,000
to 60,000 lots of the WTI $60 Jan calls early in the week at
around 8 cents. The fund then unwound some of the position last
Wednesday by selling at 10 cents, which lowered volatility.
(Additional reporting by Liz Hampton; Editing by Alden Bentley)