Traders are paying the most in three years to bet that oil prices will climb, convinced that the threat of a civil war in Iraq will disrupt supplies from OPEC’s second-largest producer.
Bullish options giving the right to buy the U.S. Oil Fund LP (USO) are the most expensive since March 2011 relative to contracts protecting against a slump in the exchange-traded fund, according to data compiled by Bloomberg. The ETF tracking West Texas Intermediate crude has rallied 3.7 percent since June 6, reaching a nine-month high this week.
Oil prices have shot up since the Levant and an al-Qaeda offshoot calling itself the Islamic State raided north Iraq, threatening to re-ignite a sectarian war in the country. Investors are watching whether the conflict spreads to the south, estimated to be home to three-quarters of the nation’s crude output.
“We have penciled in slightly higher oil prices in the second half of the year,” Stewart Richardson, who helps oversee about $100 million as chief investment officer at RMG Wealth Management LLP in London, said by phone. “This is the potential breakup of a sovereign nation and one of the biggest oil producers. This situation could not go away for some time, and we could potentially have higher oil prices for a long time.”
Bullish options volume surged last week as the oil ETF jumped the most since December. More than 94,000 calls giving the right to buy the fund changed hands on June 12, the most since August and double puts, data compiled by Bloomberg show.
Contracts betting on a 10 percent rally in the ETF, known by its ticker symbol USO, cost 4.4 points more than puts to sell, according to one-month implied-volatility data compiled by Bloomberg. The price difference rose to 4.8 points on June 13, the highest since March 2011.
“I do think the market often overreacts, but it’s always trying to front run any big problems,” Randy Frederick, managing director of trading and derivatives at Charles Schwab Corp., said by telephone from Austin, Texas. His firm oversees $2.3 trillion. “Iraq will probably continue to cause volatility in the oil markets and related products such as USO.”
The Chicago Board Options Exchange Crude Oil Volatility Index, tracking 30-day options on the USO, surged 19 percent to 17.28 since its record low on June 6 as the Iraqi army fought with the rebels and the U.S. considered a request for air support. The CBOE Volatility Index, or VIX (VIX), a measure of expected swings in the Standard & Poor’s 500 Index, slid 1.1 percent to 10.61 since June 6.
The oil volatility gauge fell 11 percent on June 17 as concern about a disruption in oil supplies eased. Iraq’s oil exports from its southern terminals on the Persian Gulf are poised to surge, a preliminary loading plan obtained by Bloomberg News showed. The nation’s oil output hasn’t been hurt by the violence, the International Energy Agency said that day.
The price of oil already reflects the potential impact from the conflict in Iraq, according to Tristan Abet, a strategist at Louis Capital Markets LP.
“A bad outcome is priced in regarding the Middle East situation,” Abet said in e-mailed comments from Paris. “Such exogenous shocks do not persist. We would not bet on a further increase of oil prices.”
The last time the implied volatility spread between calls and puts hit a high was in August. The oil ETF reached its highest level since May 2012 the following month. The difference in options costs rose to another high in February 2012, days before the fund climbed to its most expensive price in nine months. In April 2011, the USO touched a two-year high after the relationship between calls and puts hit another high.
“It has coincided with a move higher in the underlying,” Strugger said by phone, referring to such bullish options trading on the oil ETF. “What it shows is that the market usually gets it right.”
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