Managing Oil Price Uncertainty with Micro WTI Straddles
You cannot predict the future, but you can prepare for it. This is even more true for crude oil prices. Forces driving and pulling back oil prices are in full play in parallel at the same time. Oil prices remain at the risk to both the upside and the downside concurrently.
Take this week as an example. WTI prices started with a rally extending a three-day uptrend of >7% following Fed’s hint at rate cuts plus heightened tensions between Israel and Hezbollah. The rally reversed as tensions eased. Crude oil prices crashed 3.8% over Tuesday & Wednesday on fears of feeble demand.
RATE CUTS AND GEOPOLITICAL TENSIONS DRIVE OIL PRICES HIGHER
The US Federal Reserve Chair Jerome Powell has signalled that the time to pivot was about now when speaking at the Jackson Hole Symposium last week on 23/Aug. This boosted optimism for oil prices, fuelling a rally reversing a price slump caused by weak Chinese economic data and disappointing US payroll revisions.
Chair Powell’s remarks lifted market sentiment, leading to gains in oil prices and the dollar weakening. A feeble dollar makes oil cheaper for non US consumers and can help increase demand pushing up oil prices.
According to CME’s FedWatch tool, there is a 67.5% likelihood of a 25 basis points (“bps”) rate cut and a 32.5% chance of a 50 bps rate reduction at the September FOMC meeting.
Sadly, the tensions in the Middle East continue to prevail. Last weekend, Hezbollah launched rockets and drones into Israel, prompting a swift response from Israel's military, which deployed around 100 jets to prevent a larger attack.
Adding to these factors are disruptions in oil production in Libya and Colombia.
The easing of tensions between Hezbollah and Israel reduced supply fears, with some speculating that Iran might view Hezbollah's missile attacks as sufficient retaliation.
Despite easing tensions, supply concerns persist in Libya threatening to reduce oil production by 1.2m bpd.
WEAKENING DEMAND AND OVER PRODUCTION COULD PULL OIL PRICES BACK
Concerns over weak oil demand from China, a global economic slowdown on the horizon, and elevated Russian crude production is keeping oil prices under check.
Russia has exceeded its OPEC+ production targets since March, leading to excess supply that is undermining the impact of OPEC+ production cuts and keeping prices low.
On Wednesday, the EIA reported a decline of 846,000 barrels in US crude inventories for the week ending 23/Aug, falling short of analyst expectations of a 2.7 million barrel drawdown. The market response to this smaller-than-expected inventory decrease was muted.
Demand for crude and gasoline will soften as US summer driving season ends first week of September.
Expectations of weaker US gasoline demand and lower refining margins have led several refiners to scale down their operations reducing demand for crude.
The largest US refiner, Marathon Petroleum (
MPC ), announced that it will reduce its refining capacity to 90% this quarter, the lowest for a Q3 since 2020. PBF Energy ( 
PBF ) will lower its capacity utilization to a three-year low, and Phillips 66 ( 
PSX ) will cut its capacity to a two-year low.
Goldman Sachs and Morgan Stanley reduced their 2025 Brent crude forecast to USD 77/barrel and USD 75/barrel respectively. Reasons cited for reducing forecasts include weaker Chinese demand, higher inventories, oversupply from OPEC countries, and rising US shale production for the downward revision.
HYPOTHETICAL TRADE SETUP
Over the past two weeks, crude oil prices have been volatile for reasons mentioned above. Looking ahead, rate cuts in September, the ongoing crisis in Libya, and reduced US gasoline demand will fuel further uncertainty to oil prices in the near term.
This is evident from rising WTI crude oil implied volatility. Earlier on 05/Aug it slid from its YTD high of 44.7 but has started to pick up again.
Establishing a directional position amid such uncertain backdrop is rife with risks. Long straddles using Micro WTI Crude Oil Options offer an effective way to capitalize on rising volatility.
Straddles are designed to benefit from (a) significant price movements in the underlying asset regardless of the price move and (b) volatility spikes. Sharp oil price moves, and volatility spike are to be expected given the current context.
Straddles provides “unlimited” profit potential combined with limited downside risk. A straddle comprises of two trade legs, namely, a long ATM call option combined with a long ATM put option.
This paper posits a long straddle on CME Micro WTI options expiring on 17th September. Micro WTI options provide exposure to 100 barrels of WTI crude offering a smaller contract size and lower premium requirements.
Based on 30/August market prices, this hypothetical trade set-up uses CME Micro WTI Crude Oil options expiring on 17th September and involves (a) Buying a 76 ATM Call, and (b) Buying a 76 ATM Put.
The premiums for each leg and the corresponding option Greeks as shown QuikStrike Strategy Simulator are shown below for ease of reference.
The straddle requires USD 1.91 per barrel in premium for the long call and USD 1.8 per barrel for the long put. In aggregate the straddle would cost USD 3.71 a barrel. Each CME Micro WTI Crude Oil option comprises 100 barrels which translates to a premium of USD 371 per lot.
When Micro WTI Crude Oil futures trade past break-even points as shown in the chart, this straddle will deliver positive returns.
• Lower break-even point: 76 - 3.71 = 72.29
• Upper break-even point: 76 + 3.71 = 79.71
However, at expiry, if Micro WTI Crude Oil Futures prices settle between USD 72.29 and USD 79.71 a barrel, this straddle will incur a maximum loss of USD 3.71/barrel or USD 371/lot.
The straddle pay-off are summarized in the table below to augment the above chart, illustrating the potential P/L of this trade at a few settlement prices.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Take this week as an example. WTI prices started with a rally extending a three-day uptrend of >7% following Fed’s hint at rate cuts plus heightened tensions between Israel and Hezbollah. The rally reversed as tensions eased. Crude oil prices crashed 3.8% over Tuesday & Wednesday on fears of feeble demand.
RATE CUTS AND GEOPOLITICAL TENSIONS DRIVE OIL PRICES HIGHER
The US Federal Reserve Chair Jerome Powell has signalled that the time to pivot was about now when speaking at the Jackson Hole Symposium last week on 23/Aug. This boosted optimism for oil prices, fuelling a rally reversing a price slump caused by weak Chinese economic data and disappointing US payroll revisions.
Chair Powell’s remarks lifted market sentiment, leading to gains in oil prices and the dollar weakening. A feeble dollar makes oil cheaper for non US consumers and can help increase demand pushing up oil prices.
Source: CME FedWatch Tool
According to CME’s FedWatch tool, there is a 67.5% likelihood of a 25 basis points (“bps”) rate cut and a 32.5% chance of a 50 bps rate reduction at the September FOMC meeting.
Sadly, the tensions in the Middle East continue to prevail. Last weekend, Hezbollah launched rockets and drones into Israel, prompting a swift response from Israel's military, which deployed around 100 jets to prevent a larger attack.
Adding to these factors are disruptions in oil production in Libya and Colombia.
The easing of tensions between Hezbollah and Israel reduced supply fears, with some speculating that Iran might view Hezbollah's missile attacks as sufficient retaliation.
Despite easing tensions, supply concerns persist in Libya threatening to reduce oil production by 1.2m bpd.
WEAKENING DEMAND AND OVER PRODUCTION COULD PULL OIL PRICES BACK
Concerns over weak oil demand from China, a global economic slowdown on the horizon, and elevated Russian crude production is keeping oil prices under check.
Russia has exceeded its OPEC+ production targets since March, leading to excess supply that is undermining the impact of OPEC+ production cuts and keeping prices low.
Source: OPEC and IEA
On Wednesday, the EIA reported a decline of 846,000 barrels in US crude inventories for the week ending 23/Aug, falling short of analyst expectations of a 2.7 million barrel drawdown. The market response to this smaller-than-expected inventory decrease was muted.
Demand for crude and gasoline will soften as US summer driving season ends first week of September.
Expectations of weaker US gasoline demand and lower refining margins have led several refiners to scale down their operations reducing demand for crude.
The largest US refiner, Marathon Petroleum (
MPC ), announced that it will reduce its refining capacity to 90% this quarter, the lowest for a Q3 since 2020. PBF Energy ( PBF ) will lower its capacity utilization to a three-year low, and Phillips 66 ( PSX ) will cut its capacity to a two-year low.Goldman Sachs and Morgan Stanley reduced their 2025 Brent crude forecast to USD 77/barrel and USD 75/barrel respectively. Reasons cited for reducing forecasts include weaker Chinese demand, higher inventories, oversupply from OPEC countries, and rising US shale production for the downward revision.
HYPOTHETICAL TRADE SETUP
Over the past two weeks, crude oil prices have been volatile for reasons mentioned above. Looking ahead, rate cuts in September, the ongoing crisis in Libya, and reduced US gasoline demand will fuel further uncertainty to oil prices in the near term.
This is evident from rising WTI crude oil implied volatility. Earlier on 05/Aug it slid from its YTD high of 44.7 but has started to pick up again.
Source: CME CVOL
Establishing a directional position amid such uncertain backdrop is rife with risks. Long straddles using Micro WTI Crude Oil Options offer an effective way to capitalize on rising volatility.
Straddles are designed to benefit from (a) significant price movements in the underlying asset regardless of the price move and (b) volatility spikes. Sharp oil price moves, and volatility spike are to be expected given the current context.
Straddles provides “unlimited” profit potential combined with limited downside risk. A straddle comprises of two trade legs, namely, a long ATM call option combined with a long ATM put option.
This paper posits a long straddle on CME Micro WTI options expiring on 17th September. Micro WTI options provide exposure to 100 barrels of WTI crude offering a smaller contract size and lower premium requirements.
Based on 30/August market prices, this hypothetical trade set-up uses CME Micro WTI Crude Oil options expiring on 17th September and involves (a) Buying a 76 ATM Call, and (b) Buying a 76 ATM Put.
The premiums for each leg and the corresponding option Greeks as shown QuikStrike Strategy Simulator are shown below for ease of reference.
The straddle requires USD 1.91 per barrel in premium for the long call and USD 1.8 per barrel for the long put. In aggregate the straddle would cost USD 3.71 a barrel. Each CME Micro WTI Crude Oil option comprises 100 barrels which translates to a premium of USD 371 per lot.
When Micro WTI Crude Oil futures trade past break-even points as shown in the chart, this straddle will deliver positive returns.
• Lower break-even point: 76 - 3.71 = 72.29
• Upper break-even point: 76 + 3.71 = 79.71
However, at expiry, if Micro WTI Crude Oil Futures prices settle between USD 72.29 and USD 79.71 a barrel, this straddle will incur a maximum loss of USD 3.71/barrel or USD 371/lot.
The straddle pay-off are summarized in the table below to augment the above chart, illustrating the potential P/L of this trade at a few settlement prices.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
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