Oil Volatility Rebounds Amid Financial Turmoil: Energy Markets

May 10 (Bloomberg) -- Crude oil volatility has surged to its highest in almost two months as turmoil across financial markets prompts speculators to sell futures contracts.

Oil’s 30-day historical volatility, a measure of how much crude fluctuates around its average price during that period, has jumped 53 percent from near a three-year low in mid-April. Hedge fund managers and other speculators have pared back their positions in crude by 14 percent in the past month, data from market regulators show. Oil prices dropped to the lowest in 11 weeks in New York last week.

“The main driver has been risk aversion, driven chiefly by Eurozone sovereign risk issues,” said Mike Wittner, head of oil market research at Societe Generale SA in London. “There have been jitters about China, a U.S. supply glut, uncertainty over the Gulf of Mexico spill. Speculators’ net-length has been high, and so prone to profit-taking.”

Oil futures on the New York Mercantile Exchange fell to $74.51 on May 7, the weakest intra-day price since Feb. 16, as the threat of contagion in Europe weakened the region’s currency versus the dollar and dimmed the hedging appeal of commodities for investors. Oil rose to an 18-month high of $87.15 a barrel on the Nymex on May 3. Its thirty-day volatility was at 31.087 on May 7, the highest since March 15.

The Chicago Board Options Exchange’s Crude Oil Volatility Index, a measure of how much the commodity fluctuates in a 30- day period, climbed 41 percent last week, the steepest jump since its creation in 2007. It rose to 42.61 on May 7, the highest since Dec. 11.

The index is calculated using options to buy and sell the United States Oil Fund, an exchange-traded fund that tries to match the price of benchmark West Texas Intermediate crude futures on the Nymex.

Reduced Length

While hedge-fund managers and other large speculators boosted their bets in the week to May 4 that prices on the Nymex will rise, during the past month they have reduced so-called net-long positions by 14 percent, data from the Washington-based Commodity Futures Trading Commission shows.

Hedge funds’ net-long positions were at 109,870 contracts in the week to May 4, having hit a record high of 136,000 in the week to Jan. 15.

“Daily volatility that we see on crude is very much linked to the fact that oil and equities are moving in tandem,” said Olivier Jakob, managing director of Petromatrix GmbH in Zug, Switzerland. “Volatility had come down in line with lower volatility on the VIX.”

The VIX, as the benchmark index for U.S. stock options is known, surged 86 percent last week to 40.95 for the biggest weekly gain in its two-decade history.

“We’ve been calling for an increase in the VIX, and now that’s happened,” said Petromatrix’s Jakob. “It’s done most of the move.”

Brimming Stockpiles

Oil’s 30-day volatility had subsided to 20.295 on April 13, the lowest since July, 2007, as brimming stockpiles and rising investment by the Organization of Petroleum Exporting Countries eased concern over shortages.

Since then Greece’s escalating fiscal crisis has shaken investors’ appetite for risk assets such as equities and commodities. Uncertainties have also grown about the long-term impact on U.S. drilling programs after Transocean Ltd.’s Deepwater Horizon rig sank on April 22.

Some banks, such as Goldman Sachs Group Inc. and Barclays Capital, predict that erratic price variations are set to continue and possibly accelerate.

Goldman Sachs analysts Jeffrey Currie and David Greely said in a March 31 report that commodity markets are set for “violent price spikes,” as investment constraints on new supplies and emerging market demand threaten shortages.

Price Swings

Barclays’ Paul Horsnell said April 27 that price swings may intensify as global oil demand grows faster than supply and spare production capacity diminishes.

One way for traders to profit from price swings is by purchasing or selling options contracts. When volatility is expected to rise, investors may use a strategy known as a long straddle, in which they buy both a call option and a put option on the same commodity, at the same strike price. The buyer gains in relation to how far the price of the underlying stock or commodity moves, regardless of the direction, while their potential losses are limited to the cost of the options.