Don’t Slip-up (or out) on Oil
Oil is at the centre of all news. From trading floors to dinner parties, people are speculating on what will happen next. One thing is certain, the black nectar will remain volatile throughout 2015.
This is good news for exchanges and market-makers who will profit from large volumes generated off the back of volatility. But is it good news for futures traders? Higher volatility means a need for larger margins and wider stop-losses, deeper pockets, and an ability to take on more risk.
Options allow traders to profit on volatility without having to take directional risk and they allow futures traders to hedge their exposure. Therefore, it should be no surprise that CME, one of the largest exchanges in the world saw WTI crude oil options volume grow by 125% in January*.
Don’t know options? Let me explain a basic trade. An option allows you to reserve a price in the market and you pay a fee for that privilege. Say you want to reserve the price to buy 100 barrels at $60 for the next 10 days, the option will cost you $100. The reserve price is called the 'strike' price. If the market price of oil rises above $60, your strike price beats the market and you may make a profit. If oil price falls below $60, you make no profit; your loss is limited to the $100 you paid to buy the option, however low the market goes. There is no exposure to large losses or stop-outs, your maximum risk will always be $100.
This is a simple (buy) Call option trade and demonstrates how in a volatile market it’s better than buying futures, which require larger margins and risk of stop-outs. The image below shows the trade set-up in the optionsReasy trading platform.
Oil options are traditionally traded on exchanges and, by CME’s figures, are one of the most actively traded energy products. ORE have created accessibility to the over-the-counter (OTC) market, allowing retail brokers to offer their clients oil options alongside their futures trading. OTC has an advantage whereby the contract’s expiry date and reserved price (strike) can be customized. Giving traders freedom to build strategies that suit their needs.
It’s about time we lift the restraints of the retail market and open up diversity, giving brokers and their clients more freedom and choice to trade in the financial markets.