EU Embargo of Iranian Oil
Will the EU embargo of Iranian oil drive prices up or will other producers increase output? As part of an ongoing effort to force Iran to forego its supposed development of nuclear weapons officials on the continent announced an EU embargo of Iranian oil. Other measures include freezing assets of the Iranian Central Bank and forbidding the trade of precious metals or diamonds between the EU and Iran. The regime in Iran has refused to allow the International Atomic Energy Commission full access to their research facilities. Iran claims to be solely interested in developing its ability to produce nuclear power. However, the general consensus of Western nations is that Iran’s leader wants to have nuclear weapons in his arsenal. The current EU embargo of Iranian oil is meant to further destabilize the regime in Tehran and either bring it to the bargaining table or remove it from power. Other incidents in Iran include assassinations of nuclear scientists, computer viruses, and surveillance by US drones. For those trading oil options the question is how high these measures may drive oil prices and for how long.
Iran has threatened to close the Straits of Hormuz in retaliation for the EU embargo of Iranian oil and other sanctions. This would block about 12 percent of world oil production from leaving the Persian Gulf. The US Navy Fifth Fleet patrols the Persian Gulf, Red Sea, Arabian Sea, and the African coast down to Kenya. One of it carriers, the USS John Stennis recently passed through the Straits of Hormuz during Iranian naval exercises in the area. Should Iran choose to follow through with its threat it would sure come head to head with US Naval forces in the area. Part of the reason for Iran’s threat to close the straits is that Saudi Arabia and other Persian Gulf oil producers have indicated that they will ramp up their own production to make up for what the world might lose if Iran production finds no buyers. In this sort of impending crisis options trading allows traders to hedge investment risk. If, for example, a trader buys calls on oil futures he will be expecting them to go up. If Iran comes to its senses, agrees to open its facilities inspection, and forego any attempt to develop nuclear weapons sanctions could be lifted and the price of all would likely fall. By purchasing calls on oil futures instead of buying calls the trader hedges his risk when trading oil after an incident such as the EU embargo of Iranian oil.
If a trader chooses trading options on oil futures instead of buying options he is leveraging his investment capital. The costs of options are commonly much lower than the costs the commodities themselves. If the EU embargo of Iranian oil leads to a substantial rise in oil prices the trader can execute the options contract and profit. He will have done this with substantially less capital than if he had purchased oil directly. This argument applies primarily to oil producers and refiners but also to transportation companies such as airlines who can hedge their fuel price risk by trading options on oil as opposed to buying huge stocks in anticipation of a price rise. Although such times are worrisome they can go good times for trading options as futures prices may rise and fall precipitously in response to actions of or threats by the principals involved.