By Brian Noble
In options trading, a straddle is literally a sit-on-the-fence strategy. By purchasing a put and a call at the same strike (price of underlying commodity) for the same time period, an investor isn’t making a conventional directional bet; rather the investor is looking for a big move either up or down. The rub is that the big move must be greater than the sum of the two option premia or the bet goes south. But that is in the nature of the trade.
From a fundamental industry perspective (Conflicting News Keeps Oil Prices Down) to a more specifically trading focus (Are Oil Markets Becoming Untradeable?) confusion has reigned supreme in the crude oil markets of late. WTI is down about 12 percent for the month of June and is set for its longest run of weekly declines since 2015. In addition, crude has been displaying considerable price volatility on a day-by-day basis, largely to the downside. So would anybody be putting on a straddle in the WTI market today? Let’s assess the situation.
Hurricane season in the Gulf of Mexico is upon us early.
If rigs go offline because of a vigorous hurricane season, production will be shut-in and crude prices will rise. The first storm of the season has already made land-fall, and the usual season is August-November, so the storms are early this year.
How good a job can OPEC do in terms of maintaining production cuts, discipline and compliance within OPEC and non-OPEC?
If OPEC succeeds at making the cartel march to its tune, then all will be well. In addition, future even deeper cuts will help support the oil price. What realistically are the chances of that?
Can Saudi Arabia really influence the EIA inventory numbers?
The Saudis say that the current OPEC cuts need time to impact the market. But can they themselves surreptitiously impact the market? Analyst John Kilduff of Again Capital interviewed by CNBC has made the novel suggestion that it is in their hands by changing the flow of exports from the U.S. to other markets with the effect of decreasing inventories artificially. He also thinks that unless OPEC cuts much deeper, the current game of chicken is going to continue among market participants.
Is there a credit crunch looming in the patch?
At current lower crude prices, U.S. shale production could be negatively impacted over the next few months and some production could come off line as producer cash flow dries up and some of the hedges from last year begin to run off. Less drilling activity will put upward pressure on prices.
Where is the U.S. dollar really going?
If U.S. rates are going to the moon, then the U.S. dollar will rise and commodity prices fall. But what if the Fed is done with the current rate cycle? Recent strength in WTI this past week is probably a reflection of a weaker U.S. dollar—is this a sign of things to come?
The fundamental macro-economic backdrop to WTI has been bearish.
The CITI U.S. Macro-Economic Index (or Surprise Index) recently plunged to a six year low, meaning that economic data have been exceptionally disappointing. Global economic growth has been anything but robust, including a weak U.S. GDP print of under 2 percent, while even in so-called faster growing Europe, macro-economic conditions are soft.
Despite OPEC’s best efforts, the supply/demand dynamic was not effectively addressed.
Increasing U.S. production and higher domestic rig counts have also undercut OPEC’s attempts to limit supply. At the same time, declining U.S. demand for gasoline has been mirrored by declines in Japan, China and the rest of Asia. All OPEC producers, including the Saudis, have actually increased production in the last two months.
Having said that, increases in U.S. shale production, growth in DUCs and global inventory levels matter.
Limits to Nigerian and Libyan production were simply disregarded by OPEC at its May meeting, while both countries have made a surprisingly robust recovery in terms of production. But the domestic U.S. industry has proved so resilient in terms of using cost-effective technology that inventory levels remain elevated.
Who really believed the OPEC charm offensive?
The 25 May OPEC and non-OPEC member meeting in Vienna was bruited to be make or break. But even with the agreed production cuts and their 9-month extension, the cartel has been unable to keep its act together, as compliance issues are paramount and it is obvious that OPEC members are pursuing their own agendas (OPEC Members Pursue Own Agenda As Glut Persists)
The technical picture was deteriorating.
WTI was unable to break out of its $52-54 upside range. Instead, a pattern of lower highs and lower lows has been apparent since early May. Recently, WTI broke major support at $45, while Brent completed a death cross (Brent Stands at Death’s Door With Bearish Cross Formation: Chart) where the 50-day moving average falls below the 200-day, which last occurred in the latter part of 2014.
Straddle this market or not?
Violent price swings in tech stocks, gold, oil and other asset classes are a result of the preponderance of algorithmic trading plus high levels of leverage prevalent across all markets today. What used to be price discovery is now essentially noise.
Just to reiterate what I said on 6 May 2017 (How Much Further Could Oil Prices Fall?), my one dollar/one euro/one pound (name your currency) bet would still be that oil goes back to the high $20s-low $30s as it did in the winter of 2016 before it goes back above $60.