Arcane Oil Options Indicator Flashes Warning as Bulls Pile In

  • ‘Breakeven’ collapse seen indicating price volatility too low
  • Occurs amid heightened geopolitical tensions and bullish run

Phil Verleger on the Outlook for Energy Prices

Oil’s recent surge to $70, buttressed by an unprecedented flood of bullish bets, is getting options traders excited about an arcane measure of volatility that they say points to an overheated market.

The options market’s “gamma-theta” indicator, showing price moves traders expect to see each day, has collapsed in the past few weeks, according to Thibaut Remoundos, founder of London-based Commodities Trading Corporation, which advises on hedging strategies. This implies that a flood of financial flows into the market, rather than supply and demand, has lifted oil prices, he said.

“Volatility compression combined with record-breaking positioning offers an important clue into the market’s setup,” Remoundos said. “Oil markets are now flow-driven by macro-rotation to the sector, getting disconnected from fundamentals, and that tends to end badly.”

A resurgent global economy, weakness in the dollar and supply cuts from major producers have helped fuel a move by investors into commodities so far this year. Last week Brent crude, the global benchmark, traded above $70 a barrel for the first time since late 2014. Investors now hold a record number of net-long positions in both Brent and West Texas Intermediate crude. Meanwhile, the benchmark grades’ implied volatility, a separate measure of price fluctuations, has recently been near multi-year lows.


That’s where gamma-theta -- one of the more obscure measures in a market that assigns Greek letters to different aspects of trading -- comes into play. In the loosest sense the measure, also known as the breakeven, highlights the trade-off between the potential for price fluctuations and the passage of time before a contract’s expiration. The lower the breakeven, the less the market is pricing in a sharp change in the price of the underlying asset -- in this case, oil.

The breakeven on options for West Texas Intermediate crude recently dropped to its lowest level since 2006, according to Bloomberg calculations. It shows low volatility even amid unrest in Iran, an economic crisis in Venezuela and regional tensions in the Persian Gulf -- all of which should have the effect of increasing volatility. While volatility has risen somewhat in recent days, it’s still low by historical standards.

Indicators for oil options aren’t pricing in any drastic moves; instead, they’re expecting small, steady changes, according to Richard Fullarton, founder of London-based hedge fund Matilda Capital Management Ltd.

“Options across the board are pricing in little risk,” he said. “It’s probably underestimating the chance of a long washout.”

— With assistance by Michael Roschnotti

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