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Options market signals lower oil prices ahead

Lawrence Lewitinn
Lawrence Lewitinn

Crude failed to rally after Saudi Arabia, Russia, and other countries agreed to freeze production at January levels. But there may be other signals that prices will fall.

The Chicago Board Options Exchanges’ (CBOE) Crude Oil Volatility Index (^OVX) remains at elevated levels. On Tuesday, the “Oil VIX” traded at 81.12, its highest level since the financial crisis. The index is a prediction of expected volatility in oil prices in the month ahead.

Some view the Oil VIX similarly to the S&P 500’s (^GSPC) volatility index (^VIX). The latter is often used as a gauge of market fear and frequently trades in the opposite direction of the underlying index itself.

Traders should be wary of applying that thinking to the commodity volatility indices, said Russell Rhoads, director of program development at the CBOE Options Institute. Nonetheless, Rhoads sees other indicators pointing to lower crude prices.

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“Looking at the out-of-the-money puts versus the out-of-money calls, it looks like the concern is downside for oil from here,” he said.

And while the S&P 500’s VIX generally spikes as the index drops, Rhoads sees the OVX combining both current and future volatility.

“I've actually done some work where I look at the predictive ability of these volatility indexes for future volatility and they actually do a pretty good job of looking forward as well,” he said. “The fact that OVX is making new highs recently, it’s pointing to further volatility from the underlying market.”

Rhoads doesn’t have an outright prediction of oil’s next move but says the market is bias clear. “The biggest concern is about lower oil prices as opposed to higher oil prices,” he said.

“You can be like an economist and take that either way, saying that we're going to drop because there's more worry and people are afraid to get long oil,” he added, along a hedge, “or maybe we've reached a bottom because everybody's already protected against a drop to the downside in oil.”

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