Oil volatility surged on Thursday as this week's price correction accelerated in a wave of panic selling, with traders rushing to load up on USD 95 to USD 100 put options fearing further losses ahead.
Chicago Board Option Exchange's oil volatility index briefly spiked to its highest levels in almost a year, but later traded at around 37 on Thursday, up 16% on the day for the biggest rise since February 22, when traders abruptly priced in a lengthy disruption in Libyan oil supply.
US oil futures on the New York Mercantile dropped by more than USD 7.00 a barrel following similar moves on ICE Brent, and other commodity markets as investors fled the commodities complex in reaction to the sharply stronger US dollar and a variety of weaker economic reports.
Thursday afternoon the OVX was at 41.41, after trading as high as 48.64. On the daily chart, the market gapped up on the day from Wednesday's range, but for the week, the OVX had traded progressively higher. The prior week saw this index trading lower on consecutive days.
"The OVX got set up for this all week as crude prices fell each of the last three days," said Tony Rosado, an options broker at GA Global Markets in New York and long-time NYMEX floor trader.
"If the market breaks down below weekly technical support at USD 101.10, and holds it, the OVX will shoot far higher very quickly," he added.
On May 25, 2010, the OVX hit an intraday high of 49.88, before settling at 45.88. This was the last time the index traded that high.
In options trading, there appeared to be no market for upside calls, according to brokers and traders as the futures markets tumbled.
"The move in crude futures today made all the June out-of-the-money calls dogs," said Michael Korn, president of Princeton, New Jersey-based OTC brokerage Skokie Energy. "They had limited time anyway, but today the dagger was put in them."
Real-time data on exchange-traded options
The USD 125-USD 165 calls, which just last week were in vogue, were far from traders minds Thursday as outright crude prices tumbled and instead the focus shifted to puts.
Call options allow the purchaser to buy the commodity at a specific price at a time in the future irrespective of the prevailing market price. Puts are options that likewise allow the purchaser to sell the commodity. Call purchasing tends to signal bullish market trends, while put buying tends to signal more bearish trends.
Rosado said the banks were loading up on USD 100 and USD 95 puts, with the USD 95 puts getting the bulk of the day's business from June all the way through December.
Other brokers mentioned that USD 100/USD 95 and USD 100/USD 85 put spreads were popular trades, and that the trade was looking a lot more at the lower levels.
In a put spread, a trader usually buys out-of-the-money puts and simultaneously sells puts with an even lower strike price, a strategy in which the maximum payoff is expected if the commodity falls moderately.
Regarding the futures markets, Rosado said the sell-off was needed to get some of the speculative fever out.
