We are not oil experts. This is not an article arguing the reasons why oil prices may rise. This is simply an article discussing what we believe to be an outstanding trading opportunity, based purely on risk-reward dynamics. Using long dated options the returns that could be realized from a reversal in oil's recent trend are too good to pass on in our view. With a minimal capital allocation and optimizing options to strictly limit our downside on an ongoing basis, we are speculating on a rebound in the oil price. The most likely scenario is that we are incorrect and this trade loses money, but that does not mean that it is not a good trade. In fact, it is one of most compelling trades we have ever entered.

Oil Is Volatile

Stating the obvious, of course oil is volatile. However, often “volatility” is used with a direction bias. For example, commentators talk of volatile days in the stock market, largely when stocks are falling. Volatility in equities is associated with falling prices, reflecting the skew that falls in prices tend to be faster, sharper, and less expected than rallies in stock prices. This is also reflected in the pricing of options on equities, with puts being more expensive than the equivalent calls. This phenomenon is appropriately named “skew”. This is symptomatic of the risk of large drops in stocks prices relative to large gains in prices, but also of the increased demand for downside protection by stock holders, as opposed to demand for call options.

In gold options skew can vary dependant on underlying macro conditions. For in recent years as we moved towards the first Fed hike, puts were more expensive than calls, as the risk of a large fall in the gold price increased with the unwinding of the mass monetary easing by the Federal Reserve. This has now changed with the Fed on hold and the global economic outlook less stable.

Similarly, oil options can have skew.

Massive Gains In Oil Prices Are Far From Impossible