A week ago, I wrote an article which discussed how the options markets can provide clues to future price direction and/or volatility in the crude oil market. In particular, we attempted to address the question, “how can a trader spot these option clues in advance?”
Friday morning, we got a signal which may indicate volatility is in the cards again for crude oil.
As crude oil has continued its upward advance from late December, call sellers have become increasingly off-sides in their hedges and trades, and we now find ourselves at a level where option market sentiment – by our measurement – is in the 99th percentile.
We have seen a similar situation play out before in the natural gas market. When the level of market neutral gamma spikes out of the current trading range (or it becomes incalculable), then the market experienced a short squeeze.
NYMEX crude oil options are expiring next Tuesday, April 16th. While Friday’s level of neutral gamma is in range, we have forecasted that the level of market neutral gamma will spike on Sunday night – unless market conditions change. This forecasted spike can be seen in the graph below.
What Does it Mean?
The safest conclusion to arrive at in this scenario is this: expect volatility ahead. The market may experience a form of a short squeeze as option traders move to cover their off-sides net short. Or, the market will correct lower towards our calculated Price Magnet in the low $60 range. Based upon our research, we would not be surprised to see a $5 move in either direction by the end of next week.
I look forward to any feedback on these concepts in general, or on the oil market in particular.