Monday, June 17th, 2019

Oil Options Volatility


Oil options volatility is up as the European debt crisis threatens to spread to Italy and farther. Oil options volatility is a result of uncertainty. If the parties involved agree to back up Greek and Italian debt as well as that of Portugal markets will settle down. The underlying concern for oil options is that the current situation could further decrease industrial production in Europe as well as in North America and Asia. Reduced industrial production leads to less oil being used and lower oil prices. However, civil war in oil producing Libya and civil unrest throughout the Middle East could threaten production and drive the price of oil up. Traders in oil futures are concerned that oil prices could go either way and this is largely why oil options volatility is up. How to buy options on oil including knowing about oil options volatility. But, just what is oil options volatility?

Here we are talking about implied of projected volatility, not historic oil options volatility. In stock options trading historic volatility is calculated by consulting price records. Implied volatility is based upon market price projections and various pricing models. Historic options price volatility calculations provide precise numbers. Implied oil options volatility provides a theoretical value. Professional options traders often speak of implied options volatility instead of options price. The current price of an option is closely tied to its underlying equity, such as an oil futures contract. The implied volatility of this option is tied to the projected price. Those relying upon oil options volatility measurements to trade options must remind themselves of the old computer programing adage, “garbage in – garbage out.” If the information put into the formula is unreliable the output will be misleading and lead to trading losses. If the formulas themselves are poorly designed the result will be the same, inaccurate predictions and options trading losses.

Trading options offers the trader two advantages over standard equity trading, leverage and reduced investment risk. With high oil options volatility traders can take advantage of even small price swings by purchasing options. The trader only pays a premium for buying puts on oil or calls on an oil stock or oil futures contract. If his analysis of price and options volatility is accurate he can earn multiples of his investment when prices change. On the other hand if his analysis turns out to be inaccurate his losses are limited to the premium paid for the options contract. These are uncertain times for the price of oil and the profits of oil companies. Uncertainties about oil production threaten to raise prices and profits while uncertainties about industrial production threaten to decrease the price oil and oil company profits. While higher oil options volatility threatens the trader with market uncertainty it also offers the opportunity for higher profits. By closely following the fundamentals and market sentiment the trade can turn uncertainty and volatility into profits. As usual we are not suggesting that one trade options on oil contracts or oil stock or that the trader avoid these investment opportunities. Our suggestion is that traders investigate such situations and trade according to a well devised and carefully executed trading strategy.

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