Are Oil Prices Set For A Pause?

by .
Alistair Meadows
Alistair Meadows

The cost of living crisis being experienced across the Western world shows no sign of ending soon and at the centre of the inflationary vortex is the price of oil, from which ultimately all other prices are derived.

Oil Price Factors

Having reached a peak of $128 in early March 2022, prices of West Texas Intermediate crude oil (WTI) is now in the process of re-testing those extremes, as the war in Ukraine, combined with what appears to be the ending of China’s “zero -covid” strategy, is inflaming expectations of further rises in the price.

In recent days, one oil trader wagered over $7 million on the price rising to between $150 and $200 by June 2023, via the purchase of a Call spread (Buying the $150 calls and selling the $200 calls).

Oil WTI Sep 22

The problem with this scenario, (apart from the fact that it is widely shared) is that these sorts of trades tend to be made near the end of a trend, rather than at the beginning; analysts rush to up-grade their price forecasts to catch up with current pricing and traders then put on these trades, following the recent past trend.

Forecasts are not much more than guesses and fail to take into account second order effects- unless demand is assumed to be infinite and eternal, price rises tend to lead to declines, as a result of the demand destruction resulting from that rise.

There is little reason to assume that “the cure for high oil prices is high oil prices” (as the cliché goes) does not still apply.

Contrary Trades

So it makes sense to be on the opposite side of this trade; the short term Oil price action allows one to do so without any significant risk at present.

As the above chart shows, there is quite a bit of support around the $105 area and longer trend resistance is now above $100 (and will be around $104 in around one month). Thus, a break of these levels will suggest a significant trend change.

One way to play this is to buy a put calendar spread, whereby one sells an August 104 put on US Crude and buys a put spread on September oil.

So, a sale of the August WTI 104 Put (expiring on 15/10/22) would generate a credit of 144p currently, (as of 12/06/22) offsetting the cost of buying a 104-102 put spread, which would cost 75.1p.

This trade results in a net credit of 68.9p at current prices, implying a small profit unless the price falls substantially in the next 6 weeks. (The breakeven for this position is around $102.50 assuming an expiry, as per the 15/7/22 close).

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