Drill, baby, drill. This was the refrain spoken by President Donald J. Trump at many of his political rallies over the last several months. The idea is that President Trump wants to unlock the energy reserves of the U.S. from a regulatory perspective. The oil market heard those refrains as well. In the chart above one can see when the odds of a Trump presidency went higher, oil prices went lower. When his odds went lower, the price of oil went higher. There is logic to this of course. If the U.S. is going to increase oil supply, all else equal, this should be negative for oil price.

In the hours after the U.S. presidential election results became clear, the oil market responded again by heading lower in the late hours on Tuesday and early hours on Wednesday. However, something changed midday. Oil reversed course and ended up higher on the day. What happened? The narrative began to change somewhat. Oil analysts focused on a few different aspects of a Trump regime than had been discussed before. First, there were views that sanctions on Iran would remove this excess supply overhang from the market. Second, as traders saw with the rally in the stock market, the expectation of lower corporate taxes and lower regulation on oil companies may be spurring a view that demand for oil could be higher than it has been. Both potentially can offset any near-term concerns of an increase in supply from U.S. oil companies.

Supply and demand is clearly the big story in the oil market. I have shown this chart before. The OIL S/D Index I created is the difference between world oil consumption and world oil supply, as reported by the Energy Information Administration of the U.S. Department of Energy. I have drawn horizontal lines at +/- 1.5% to show when supply and demand becomes mismatched by an amount that can begin to move markets. In fact, I have highlighted those times when either demand outstrips supply (above the 1.5% line), or supply outstrips demand (below -1.5% line). The arrows show the response in the oil markets to this supply/demand imbalance. At the far right of the chart, I have circled where things are now, at 1.93%, with demand outstripping supply. Could this potentially mean higher oil prices in the near-term?

The market has another major catalyst ahead of it – the December 1 OPEC+ meeting. In order to assess what the market is thinking about this meeting, CME Group has OPEC Watch.  This tool shows in the few weeks before the meeting what the market expectations are. An explanation of the tool comes from the CME Group website:  

With OPEC Watch, an implied distribution will be derived in real time from the generated December 1 expiration: 

• The probability area ≥ +1 SD price will be the ‘Further Delay Increase’ %
• The probability area ≤ -1 SD price will be the ‘Increase Output’ %
• The probability area > -1 SD and < +1 SD will be the ‘No Plan Change’ %

I can see the most likely expectation is for “No Plan Change” with a probability of 65% plus. If there is any surprise, the market is pricing in higher odds that this surprise could lead to an increase in output rather than a further delay increase. As the distribution is generated from the options market it could perhaps indicate a slightly higher concern for a surprise that could yield a downside price move in the futures price.

In order to get a sense for how the oil market may be positioned into the U.S. election and ahead of the OPEC+ meeting, I turn to the Commitment of Traders data I get from CME Group. Looking at the data over the last three years, one can see the length among levered money is at or near the lowest it has been since Spring 2023. While traders are still net-long oil, it is at less than half the long positioning that has existed over the last few years. Thus, there is potentially capacity to add length ahead of the next catalyst before the markets.

Turning to the charts, the daily ichimoku chart shows there is some overhead resistance to futures prices in the near term. However, this overhead supply has not held back prices earlier this year or even in June immediately after the June 1 OPEC+ meeting. In fact, the MACD (middle panel) is potentially turning higher indicating the possibility of a change in trend. There is a set-up here where a move above 75 in the front month futures could point to a breakout that would have more legs. However, traders also need to recognize that the next few dollars to the upside will be met with resistance from the bears who will attempt to remain in control.

Turning to the volatility markets, I look at the CVOL data to get a sense for how option markets are interpreting events. In the top chart, one can see the CVOL Index compared to underlying oil prices. At the far right of the chart, one can see CVOL has moved higher as prices have moved lower. In fact, the CVOL is at or near the highest levels markets have seen over the past year, suggesting some level of uncertainty being priced into the markets. In the bottom chart, I look at the UpVar, DownVar and skew ratio, which is a ratio of the first two. This attempts to show if the demand for options is coming from upside options (relative to at the money), downside options or both. The skew ratio has spiked to the highest traders have seen in the last three years. A trader might see that this is driven by a demand for upside options relative to both the at-the-money and to downside options. Traders appear to be getting long upside either as protection against short positioning ahead of lower prices or as a way to position for a higher move in oil that has the embedded put protection instead of simply buying futures.

Within QuikStrike I also get some other information that is quite useful in putting a trade together. In the top chart, I can see the term structure of implied volatility. This will tell me about the differential pricing for the various expirations across the curve. As you can see, there is a dip in implied volatility after the U.S. election and before the OPEC+ meeting. In the expirations immediately after the OPEC+ meeting, there is a move higher in implied volatility suggesting more uncertainty expected.  The bottom chart shows the entire implied volatility surface, not just the at-the-money options, but also the strikes on both the upside and the downside. One can see on this surface not only the higher implied volatility in the expirations post OPEC+, but also the higher implied volatility for the upside strikes relative to the at-the-money. Looking at the dates in early December, I also see that the downside strikes are priced at the same level as the at-the-money, so no premium to out of the money puts.

While one can see that there is a premium to the expirations immediately following the OPEC+ meeting, how much volatility is priced in for the event itself? In order to determine this, a trader can use the Event Volatility Calculator from CME Group. Putting in the date of the OPEC+ meeting, the calculator tells us that there is an 80% implied volatility (roughly equivalent to a 5% move on the day) priced in the OPEC+ meeting. This is considerably higher than any of the expirations around the event. Is it possible the market is overpricing with any reaction to news that comes out on December 1?

Putting these ideas together into a trade idea, I draw to six different conclusions. First, the market could potentially be changing the narrative on what a Trump election means for the price of oil. Second, current supply/demand imbalance points to higher prices. Third, Traders are not heavily positioned for an upside move. Fourth, technicals show some congestion to the immediate upside, though not getting cleared until price moves above 75. Fifth, there has been more demand for upside options relative to both at-the-money and downside options. And sixth, the market is pricing in considerably volatility, perhaps too much for the OPEC+ meeting in December.

This tells me I want to find some bullish directional idea, but perhaps one that allows me to sell some options and lean short volatility, particularly the near-term upside options, which have been in demand and may be overpriced. That said, I do need to cover the upside, because a move about 75 could lead to a breakout in price.

A very nice feature in the WTI market is that WTI Weekly options from CME Group now expire every day of the trading week and are listed for the next four weeks. This is in addition to the standard monthly options that are already listed. When one week of options rolls off, another week, four weeks out, gets listed. Thus, there is always a Weekly option for the next four weeks to consider. So, no matter the cause of volatility, a trader has ultimate flexibility as to which expiration to choose to reflect a view.

This leads me to consider Monday WTI Weekly options to hedge the December 1 OPEC+ meeting. I look to buy 70.5 calls, slightly in-the-money, since downside options have no premium in volatility terms. I have chosen to finance this by selling the same expiration 74 strike calls, which have a volatility premium priced in. I cover the upside tail with 76 calls, which will enable me to lock in a profit on a move that goes through all of the strikes of the butterfly.  The risk of this butterfly would be a move lower in price where I lose the premium invested. This premium might be reduced due to the differing volatility of the options I buy versus those I sell. I have a defined risk strategy that allows me to make multiples of the amount of money that I put at risk. Profits are maximized if prices after OPEC+ go to 74 and sit. In this scenario, I could net more than three times the money I put at risk. Even if prices continue higher and break out above 75, I will still double my money, so I benefit even on a big move, which is not the case in a butterfly with asymmetric strikes.

Using the tools provided by CME Group, a trader is able to more finely tune their views and their strategy, considering what is being priced into futures markets and options markets from the catalysts or events on the horizon. This has the potential to improve the reward to risk for strategies traders embark on.

Good luck trading.

The opinions and statements contained in the commentary on this page do not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs. This content has been produced by [Data Resource Technology]. CME Group has not had any input into the content and neither CME Group nor its affiliates shall be responsible or liable for the same.

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