Oil traders raced to abandon complex, bearish options trades in U.S. crude this week, after the market rapidly shifted to reflect tighter supplies at the key Oklahoma storage hub over the past month, leading to a surge of activity in a typically illiquid corner of the market.
Because of new pipelines flowing out of the Permian basin, the biggest U.S. shale field, to the Gulf Coast, shipments to Cushing, Oklahoma, the delivery point for U.S. crude futures, are expected to dry up. Inventories have already dropped for seven straight weeks at the vital storage hub – at a faster-than-expected rate, traders said.
Trading in U.S. crude spreads, a proxy for expected inventories in Cushing, has been roiled, leaving traders scrambling to ensure they are not caught on the wrong side of the rally. That volatility extended to the calendar spread options market as well, which is normally quiet.
The spread between U.S. crude futures for October delivery versus November has whipsawed, rising to as much as a 48 cent-premium per barrel this week, highest since May, after trading at a discount just three weeks earlier. That is a signal that supplies are expected to tighten quickly by October.
Traders also were forced to exit bearish calendar-spread options (CSOs) into the fourth quarter, market sources said, because of the signs that Cushing supplies are expected to remain tight.
Volumes in CSOs have surged, according to data from CME Group’s daily bulletin and brokers executing the deals, with about 12,500 lots of put options on the October/November U.S. crude spread unwound on Monday.
What is unusual about that activity is that these option contracts sometimes go days without a single trade, unlike underlying futures contracts, which trade actively.
CSOs are usually used by oil producers and traders to hedge against, or speculate on, a change in the shape of the oil futures market structure.
The U.S. crude futures curve flipped this month to backwardation, where near-term prices are higher than forward prices, an indication of tightening supply.
“People are being forced to take barrels out of the tanks. Even if they don’t want to, they have to, it’s the economics,” one broker who executes CSO trades said.
CSO activity in the first half of next year, however, has been concentrated in bearish contracts, dealers said, as traders took out insurance against changes in fundamentals again and a potential oversupplied market.
Overall open interest in U.S. CSOs has risen to about 202,000 lots as of Aug. 13 from 174,000 lots late in July, according to CFTC data.
