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Volatility has risen for options on oil futures. Usually this has to do with basic supply and demand issues and associated market uncertainty. This time it has to do with interest rate driven oil futures options. In short the Federal Reserve has been buying $85 Billion in treasury bills every month. This has served to keep interest rates low and help with the economic recovery in the USA. However, the Fed will now keep this up indefinitely. According to recent comments by Fed chairman Bernanke, the Fed will gradually ease off of this policy as the economy improves. As is often the case word or two by the Fed chairman can rile the markets. In order to make a profitable option trade, a trader needs a glimpse of the future. When we have interest rate driven oil futures options traders look to the Fed for a hint of where interest rates and the economy are going.
Uncertainty Begets Volatility
The most profitable options trading commonly occurs when markets are volatile. Options are, in fact, made for volatile markets. When a trader buys calls or puts on a futures contract he or she need only execute the contract if it is profitable. A call gives the trader the right to buy and a put gives the trader the right to sell. In neither case is the trader obligated to do so. Thus an options trader can buy puts and calls in a volatile market and limit his or her risk to the price of the contract. In addition, buying options provides the trader with leverage. He or she does not need to buy or sell the underlying equity but rather pays to stake out a position which may be lucrative. The more volatile the market, the more profit a trader may be able to gain. Currently puts are running two to one to calls which tells us that more traders believe that the Fed will ease off and that interest rates will rise. The result will then be a cooling off of the economy and a reduce demand for oil.