Options traders bet oil could rise another 40%

By Robert Campbell
Reuters
Friday, June 27, 2008

http://www.reuters.com/article/reutersEdge/idUSN2742649220080627?sp=true

NEW YORK -- Oil options have spiked to prices that imply crude could rise another 40 percent as recent big moves in the crude contract prompt heavy buying of protection against further price increases.

Implied volatility, the theoretical amount traders expect oil to move based on the price they pay for an option, has surpassed 40 percent on many key contracts, according to calculations made from Reuters data.

"There's a great deal of uncertainty where prices are going," said John Kilduff, senior vice president at MF Global in New York.

"It shows how dear supplies are seen by a lot of people and just how powerful this bull market is and it could push more people into the bull camp when they see the prices people are paying for these options."

The December $150-a-barrel call option hit $11 a barrel by midday on Friday, up nearly eightfold from $1.45 a barrel on May 1.

A $150 call option gives the buyer the right but not the obligation to buy the underlying futures contract at $150 a barrel. A trader who intended to exercise a $150 call after paying a $11 premium would not make a profit unless oil futures surpassed $161 by December.

Oil prices have jumped more than 45 percent this year to top $142 a barrel on Friday on tight global supplies, shattering records and hammering automakers, airlines and cash strapped consumers.

"There is some larger institutional money and hedgers going into (options) but for the most part, this is purely speculative. Crossing the $140 a barrel mark has spurred a lot of buying," said Rob Kurzatkowski of optionsXpress in Chicago.

But while the rise in the price of the underlying futures contract has helped push up the value of some options, analysts say the huge price swings in oil futures, that have become more common since the beginning of the year, are the main driver.

"A lot of traders are thinking if (oil) can move $5 in a day, it can easily move $25 in a week," said Peter Beutel, president of Cameron Hanover in New Canaan, Connecticut. "It is insurance and insurance is getting very expensive."

... Not all bulls

Still, analysts caution against reading too much into options prices, particularly when volatility rises, as traders may be deploying any number of trading strategies rather than simply betting on further price increases.

"Just because someone is buying a $150 call for $10 a barrel doesn't mean we know anything about their larger view of the market or their overall portfolio," said Tim Evans of Citi Futures Perspective in New York.

"They might, for instance, be selling the futures market short today and this is their stop-loss."

However, some traders say bids for options have pushed prices beyond their fair value, which has brought sellers into the market seeking to profit from the situation.

Open interest in December $150 calls has jumped from 11,552 contracts on May 1 to 20,782 contracts on June 26 even as the price has surged.

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