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Options Strangle Is BNP’s Lesser Evil for Trading Stable Crude

Selling crude options contracts to lock in prices above and below current cost are a “relatively safe bet,” as futures will probably remain bound in a $10-a-barrel range, BNP Paribas SA said.

Less volatile prices of West Texas Intermediate will cap the value of both “call” options, used to lock in prices above the cost of futures, and “put” options, which secure prices below the cost of futures, BNP said in a report yesterday. This creates an opportunity to profit by selling a “strangle,” composed of puts and calls, for front-month deliveries of crude, according to the bank.

“Lower volatility currently limits option trading alternatives,” Harry Tchilinguirian, BNP’s head of commodity markets strategy in London, said in the report. “Selling strangles may be the least-worst option.”

While WTI will is set to advance by the end of the year, the increase may not be sufficient to ensure profits from betting that call options will appreciate in value relative to puts, BNP said. Instead of this trade, selling an options strangle may be the “lesser of evils,” according to the bank.

BNP advises a position that bets July WTI, trading at about $95 a barrel in New York today, will remain in a range of $89 to $98. To implement this, the bank recommends selling puts that allow the user to sell the contract at $89 and also selling calls that enable the user to buy July WTI at $98. The trade would pay $1.82 for each standard 1,000-barrel lot, giving an investor $1,820 per contract.

The bank advises trading options for July, the front month contract on the Nymex, because their value will decline more quickly than later-dated contracts, a concept described by options traders as “time decay,” or “theta.” The diminishing value helps investors to close their position more easily in the event that swift movements in oil futures cause the value of the options to appreciate.

-- Editors: Raj Rajendran, Lananh Nguyen

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