Oil futures posted their largest gain in more than a year last week. And the frenzy was even bigger in the options market.
As traders fretted over the risk of a major price spike, the call skew on second-month West Texas Intermediate futures jumped to the highest since March 2022, when Russia’s invasion of Ukraine sparked concerns that millions of barrels a day of oil from one of the world’s top producers would suddenly disappear from the market.
In a stunning turnaround, hedge funds, commodity trading advisors and other money managers raced to reverse positions that in mid-September had turned bearish on crude on concern that slower economic growth in China and elsewhere would crimp demand just as OPEC+ producers were getting set to boost supply. About two weeks ago, put volume peaked, with traders paying up for bearish options as futures slumped toward $70 a barrel.
But the escalation in the Middle East has changed everything. While some traders got out of calls they had previously sold, most are now looking to buy insurance against a surge in prices.
“We have seen a sizeable bid in volatility and increased demand for upside exposure to oil prices,” said Anurag Maheshwari, head of oil options at Optiver. Implied volatility has surpassed a high from October of last year, “which seems reasonable given that this escalation is potentially more impactful on oil supplies.”
Last week, traders snapped up December calls on Brent crude to bet on oil reaching $100 or higher, with aggregate call volume hitting a record on Wednesday. WTI futures surged as much as 11% amid concern that Israel might strike oil facilities in retaliation for Iran’s missile attack, raising fears of a Middle East supply disruption. The concerns eased slightly on Friday as US President Joe Biden sought to discourage such a move.
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Money managers’ net long positions in Brent crude jumped by more than 20,000 contracts in the week through Oct. 1, according to ICE Futures Europe data, extending a bullish shift that started in earnest after China announced a massive stimulus package to bolster its economy.
“Option traders had given up on the idea of a rally, leaving the implied volatility in oil call options near multiyear lows,” said Carley Garner, senior strategist and founder at DeCarley Trading. “In essence, the market was unprepared for the surprise, and we are seeing FOMO now that prices are finally moving in favor of the bulls.”
As well as outright crude prices, traders also snapped up outlandish bets on the futures curve structure rallying heavily. More than 5 million barrels wagering on the nearest Brent spread hitting $3 a barrel traded last week — it was at 62 cents on Friday.
The stress on the market was seen most in short-dated contracts, with the term structure for 25-delta options showing that the bullish trading spiked in recent days. Implied volatility for December calls climbed more than 30 points last week, more than triple that for puts, while there was almost no change for either bullish or bearish positions for July contracts and onward.
The bullishness for the commodity — both on Brent and WTI — has exceeded that for producers, which are likely to see a benefit only if prices remain higher for longer. Volatility and call skew in one-month options on the US Oil Fund LP exchange-traded fund both surged more than for the SPDR S&P Oil & Gas Exploration & Production ETF.
“The escalation in the Middle East has sparked a massive amount of short covering in crude oil as CTAs have flipped from short to neutral,” said Rebecca Babin, senior equity trader at CIBC Private Wealth Group. “Fundamental energy investors remain fairly sour on 2025 and are using call options as opposed to chasing the rally in crude to get upside exposure to a potential supply disruption.”