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What's Oil Put Demand Telling Us?

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At one point or another, it looks like crude will head lower.

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Cancel that Prius, just like commodity technicians Fall Out Boy once sang, "Oil, We're Going Down".

OK, it was "sugar," but oil is definitely going lower. Seriously.

Why you ask? Because the puts are overpriced, says Bloomberg.

The gap between prices of options betting on a decline and those that would profit from a rise in oil widened to a record 10 percentage points, according to five years of data compiled by Banc of America Securities-Merrill Lynch. Crude stockpiles in the US are 14% larger than a year ago and OPEC is pumping 600,000 barrels a day more than the world needs, according to the International Energy Agency.

...Options granting the right to sell, or put, oil in December below current prices have a so-called implied volatility of 54.3%, compared with 43.3% for the equivalent options to buy, or call, data from the New York Mercantile Exchange show.

The premium for December and other put options shows "the market is worried," said Harry Tchilinguirian, a senior oil analyst at BNP Paribas SA in London. "If puts are pricing higher than calls, we are looking at a situation where the market is more averse to the downside and is looking for more compensation" for the option, he said.

Demand for puts may be caused by speculators betting on lower prices or by producers hedging against a decline in the value of their oil, Tchilinguirian said.


Well, technically it doesn't say the options will be right, it's just presented as consistent with everything else in the article that points to an oil decline. But because we're covering options, let's stick with this.

As my friends Jared and Don would surely agree, Bloomberg gets a bit "so-called" happy. News-flash: It's not "so-called" implied volatility you refer to, it is implied volatility.

But more important than semantics, it's unclear what options we compare here. Are we talking puts and calls of the same strike, in which case the disparity of put volatility to call volatility is about cost of carry and not sentiment. (I mean so-called cost of carry and so-called sentiment).

Are "equivalent options to buy" a call with a similar delta or similar distance from the current price? In other words, are we comparing a put that's 10% OTM to a call that's 10% OTM? I have no clue, all I know is that it's a record.

I know precious little about oil options and oil futures, but I'm familiar with using options data as a sentiment tool. And in my humble opinion, the writers read this backward.

Is there some sort of history that demonstrates that this setup has led to oil declines? Because in the absense of that, relative over-demand for puts is bullish, not bearish. We had a similar situation in our plain old index options all summer when we saw excess put demand (and call demand in VIX options).

Now the gist of the rest of the article may very well be correct. Maybe oil is overpriced. But if everyone knows it's overpriced and starts playing it that way, that likely has to play itself out before oil actually goes lower.

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No positions in stocks mentioned.
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