The OPEC meeting on November 27, along with the November 24 deadline for talks between Iran and the G5+1 group of nations, continues to create much uncertainty in the oil market. Nowhere is this more visible than in the options market where downside protection remains in strong demand.
Over the past week, at-the-money one-month volatility has risen by more than 3% as a potential failure by OPEC to curb supply could send the price of crude oil down even further. As a result, the volatility curve is heavily skewed towards downside protection.
Gamma hedging from banks who have sold what a few months ago were deep out-of-the money puts to producers and others looking for protection have also generated increased activity.
As the price of crude falls, the delta on these former out-of-the money puts rises dramatically, thereby triggering additional selling from banks looking to hedge this exposure.
The volatility spread between what traders pay for downside protection via puts compared to similar calls has risen to 7.5% as traders are now paying close to 40% for low delta puts.
Taking a look at the most active traded options strike during the past week we find that the activity has been overwhelmingly skewed towards puts. Apart from the January 2015 USD 80/bbl call, the following six are all put options with the January 2015 USD 70/bbl put currently trading at 95 cents/bbl.
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