Oil-Options Covering Adds To Market Chaos, Fueling Crude Selloff
This note for Bloomberg may be of interest. Here is a section:
Eoin Treacy's view -
Exposure to plummeting oil prices via the options market has forced some financial firms to dump crude futures, accelerating a selloff that has sent prices plunging to the lowest in over a year.
Banks and other financial institutions typically take on futures positions to offset some of the price hedging they do for oil producers and other customers. But as oil prices collapse rapidly, the firms’ exposure rises, forcing them to exit their futures positions in a strategy known as delta hedging.
That’s driving some of the day’s selloff, UBS Group AG analyst Giovanni Staunovo said in a note. A massive number of WTI options contracts that were sold at $70 and $75 a barrel needed to be covered once oil futures crashed below those levels, market participants said. For Brent, more than 24,000 put options were open at $80 and $75 a barrel for May, both levels that were breached this week.
“Financial institutions now need to avoid having a price risk on their balance sheets,” Staunovo said in his note. “So, they are selling crude futures to offset the risks, amplifying the rout.”
The oil futures curve is still in backwardation but the gap between the 1st and 2nd month continuation charts is quite narrow and beginning to contract again. Generally, the turn in the spread between the 1st and 2nd months coincides with significant reversals in the oil price. Only three weeks ago the move into backwardation was supporting the view prices would resolve on the upside. That’s been negated by the breakdown yesterday.
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