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Oil Options Skew Strikes Again

Over the past decade, more positive (or in other words, less negative) than average skews for WTI and oil products have often presaged below average returns on long futures positions over the next three months.  The data in figures 7, 8 and 9 show the relationship between the two-year rolling percentile rank of the “risk reversal” skewness and subsequent three-month returns in the reinvested futures positions rolled 10 days prior to expiry.  Generally, a more positive skew indicates a higher likelihood (but by no means certainty) of a lower return (fall in prices), whereas exceptionally negative skews often signal that energy markets are oversold.

Whether WTI and product prices decline this time, as the past relationship between options skews and subsequent movements in prices suggests is more likely than not, depends, of course, on how both fundamental and geopolitical factors play out.  If inventories fall sharply, a possibility given that as much as half of Saudi oil output was offline for two or three weeks, that could boost oil prices.  Likewise, any strengthening of global demand or a supply shock of any sort could send prices much higher.   Indeed, the options markets is more concerned than usual that such upside could happen.  That said, options skewness has proven to be somewhat of a contrary indicator of near-term price direction over the past decade.  It’s often been that when oil traders were most worried about future price declines, prices, in fact, rebounded and when they were most concerned about upside risk, prices have the greatest propensity to fall. This inverse relationship is noticeable in WTI and much stronger for New York Harbor Gasoline (RBOB) and ULSD.

Finally, it’s worth pointing out, that in the month since the Saudi attacks sent options skews to their highest since 2011, oil and its product prices have indeed lost all their gains. The oil options skew strikes again.

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By: CME Group

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