Using Options Prices to Assess Oil Market Opportunities
Sometimes the Oil market has a bearish response to what conventional wisdom suggests is a bullish event: price falling after an OPEC cut or a large reported inventory draw. One reason this can happen is that the bullish event has already been priced into the market.
Options prices offer insights into market expectations. The prices of puts and calls on WTI provide an implied probability-weighted distribution of expected outcomes for oil price. The process for fully extracting the distribution is complex. However, there are several approximations that traders and analysts use to determine the market expectations for crude oil:
- Using the option delta to determine the implied probability that the oil price is above or below a certain level
- Finding the implied probability oil is within a range with an option butterfly
- Estimating an expected distribution of oil prices with a series of butterflies
- Comparing expectations for an event with Weekly options
These methods further explored below are instructive for assessing the Oil market, and can be compared to independent analysis and expectations to identify new trade opportunities.
- Using the option delta to determine the implied probability that the oil price is above or below a certain level.
The delta of an option represents the change in the options’ price or premium due to the change in the underlying futures price. This value is typically readily available along with other option details on most trading platforms and market intelligence tools. At-the-money options have deltas around 50% or .50, meaning that a $1 move in the futures price will create a $0.50 move in the options price. As a call or put becomes more out-of-the-money its delta will decline.
The table below reflects the deltas for a series of puts and calls on the September 2024 Light Sweet Crude Oil futures contract as of July 22, 2024. Puts have negative deltas while calls have positive deltas.
Table 1: Options Details for the September 2024 Light Sweet Crude Oil Futures (LOU4) on July 22, 2024
The absolute value of the delta is also the approximate probability that the option will finish in-the-money. For example, the delta on a put with a $73 strike price (LOU4 73 P) is -0.15: the options market is implying that on July 22, 2024, there was about a 15% chance the crude oil price would be below $73 by the expiration of the September option on August 15.
Use case: A trader believes that support from OPEC and the SPR refill in the low $70s makes it highly unlikely (<10%) that the September WTI futures contract settles below $75. However, the $75 put reflects a 25% probability oil settles below $75. The trader considers selling the put and collecting $0.80 in premium.
As no calculations are required and option deltas are readily available, option deltas are often the quickest way to understand implied price expectations.
- Finding the implied probability oil is within a range with an option butterfly
Options butterflies provide an alternative look at option-implied probabilities for the oil market. A butterfly is an options strategy that buys and sells puts or calls with different strike prices but the same expiration. A long butterfly involves buying a call at a lower strike, selling two calls at a higher strike and buying a fourth call at an even higher strike. In a standard butterfly, the differences between the high and low strikes and the center strike price must be equal.
Using Table 1 above, a butterfly could include buying the $79 strike call (LOU4 79C) for $1.50, selling two $80 calls (LOU4 80C) for $1.11, and buying the $81 call (LOU4 81C) for $0.82. The cost of this butterfly is $0.10. The butterfly allows you to profit if the price of LOU4 is between $79 and $81, with a maximum payout of $1 if the price is $80, as shown in the graph below.