Do me a favor: Humor me for a quick bit of incremental information on yesterday’s (re)collapsing in crude.
On Tuesday evening , while documenting how oil decided to celebrate the one-week anniversary of the largest one-day plunge in more than three years by staging the second-largest one-day plunge in three years, we gently suggested that dealer gamma effects were likely at play just like they were last Tuesday.
Regular readers know I make it very clear when I intend to aspire to profundity and the flipside of that involves making it equally clear when I’m just stating the obvious. Unlike some of the folks I’m often compared to, I’m not in the business of pretending like my analysis is unique or otherwise impressive when it’s not.
With that in mind, do note that when we suggested that dealers were likely auto-dumping oil on Tuesday to stay hedged on the puts they sold to producers, we weren’t saying anything that wasn’t obvious. Clearly, the rapidity of Tuesday’s crude collapse was down to hedging flows and we said as much, citing a Goldman note from last week.
Long story short, these kind of moves don’t generally happen without some kind of technical accelerant:
Well, sure enough, Bloomberg would later confirm that assessment.
“The selloff — just like the previous Tuesday — was exacerbated by banks selling futures to rebalance their positions as prices fell”, an article published on Tuesday evening reads. Bloomberg cites market participants who pinned the blame at least in part on a massive Petrobras hedge. Apparently, the oil giant was hedged at a Brent $65 equivalent and once that position got pushed into the money, banks started selling to rebalance.
Goldman is out with a followup to last week’s note and they reiterate the point. “We believe this renewed collapse reflects concerns over excess supply in 2019 [but also] technical positioning factors exacerbating volatility such as negative gamma effects [and] low trading liquidity ahead of Thanksgiving”, the bank’s Damien Courvalin writes.
Courvalin goes on to delve into the fundamental backdrop which is of course well-worn territory. As for the near-term, though, he reiterates that as long as we’re sitting in and around these key strikes where the OI is concentrated, you’re likely to see more volatility.
“Oil price volatility is likely to remain elevated in coming weeks, and we believe it will take a fundamental catalyst for prices to stabilize and eventually trade higher”, he says, adding that “price volatility is currently exacerbated by negative gamma effects with the large concentration of open interest in put positions at the $50/bbl, $55/bbl, and $60/bbl strikes likely to keep price volatility extremely high in such a range.”
In the Bloomberg piece linked above, Javier Blas notes that “Brent implied volatility for February contracts jumped to 50.4 percent Tuesday, from 36.3 percent and the skew jumped to almost 10 points.” This isn’t an exact visualization of the former point there, but it gets the job done:
Do note that when it comes to the “fundamental catalyst” needed to push prices higher, Goldman suggests what might be necessary is “physical evidence that OPEC production is sequentially declining and further proof of demand resilience.”
Well, on Wednesday morning, industry executives who watch Saudi output said the Kingdom’s production surged to a record near 11 million b/d in November. On the bright side, the catalyst was a demand surge stemming from buyers hunkering down ahead of lost Iranian barrels.
Of course ultimately, I suppose the only thing that really matters is Donald Trump’s Twitter feed and he made it abundantly clear today that he expects the Saudis to push prices even lower now that Prince Mohammed owes the White House a solid.