For much of this year, selling oil volatility has been one of the market’s most profitable trades. That ended abruptly this week.
(Bloomberg) — For much of this year, selling oil volatility has been one of the market’s most profitable trades. That ended abruptly this week.
Crude volatility surged higher on Wednesday as worries about the outlook for global economic growth and the potential impact on consumption dragged futures prices lower, sparking a flurry of options trading, according to traders and brokers involved in the market.
Traders who positioned for prices in excess of $100 a barrel were suddenly scrambling for protection. Bullish bets were rolled down to lower levels, and some traders raced to hedge themselves against further drops. Those moves showed up in surging options volumes and a jump in the premium for bearish puts over bullish calls to the biggest since June.
Crude’s descent in recent days has been almost as quick as its rally into the mid-to-upper $90s. A combination of concerns over the outlook for fuel demand — most notably gasoline — and technical selling exacerbated the move, sending shockwaves through futures and options markets alike.
Such sharp price swings also often catch out market makers who supply options to producers and consumers. When that happens they can be forced to sell futures to hedge contracts they sold. That effect, known as negative gamma, combined with traders abandoning short volatility positions contributed to major moves in the options markets on Wednesday.
“We also saw a meaningful increase in implied volatility,” said Greg Sharenow, a portfolio manager at PIMCO. “While not at peak distress, it also suggests that some negative gamma led to additional selling pressure.”
The clearest sign of pressure shows up in options volumes. For the Brent global benchmark trading was the most active since April. For US benchmark WTI, volumes reached the highest since March on Wednesday at almost 300,000 lots.
Volatility also spiraled higher. A gauge of implied volatility for WTI, which effectively reflects how expensive options are, jumped by the most since May.
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