Iranian Nuclear Deal; Its Impact on Crude Oil
A 10 year deal has been reached between Iran and the G5 countries plus Europe today which will limit Iran’s capabilities towards obtaining a nuclear weapon. The deal will see Iran’s stockpiles of enriched uranium reduced, reduce the number of centrifuges by two thirds, increase the time it would take for Iran to acquire material for a bomb, prevent Iran from producing weapons grade plutonium and track Iran’s nuclear activities with robust transparency and inspections. But most importantly this agreement will lead to sanctions from the UN and other restrictions in global trade to be lifted.
Iran has the world’s 4th largest proven Crude Oil reserves; some analysts estimate the country could add up to an extra 1 million barrels a day once production reaches capacity, this may add more downward pressure on the price of Crude.
Over the last month, WTI Crude Oil has been in a steady decline apart from the last five days where price action has been mostly range bound between 50.85 and 53.65, see chart below.
Price today has risen after the Iranian deal, but still remains within the range of the channel. It is not clear whether the US congress, which has a Republican majority, will actually ratify this agreement. This could leave Iran facing some tough restrictions, even if they are unilateral, and America’s influence may eventually put pressure on other countries to follow suit; possibly leading to less Crude Oil supply than may be expected. Congress has 60 days to decide if the USA accepts this agreement or not, this opens the scenario for a lot of volatility as news of acceptance or rejection filters through the markets.
How to trade WTI OIL volatility?
If you think the price of Crude will rise in the coming days then you may take advantage of this by buying a Call which gives you the right to buy Crude Oil at a predetermined price (called strike) before a certain date (called expiry), both of which are parameters to be chosen when buying the option.
Let’s say you buy a Call option, as shown in the image below; with expiry in 2 days and the right to buy Crude at $53.00 per barrel before expiry for 100 barrels, the total cost of the option is $35.27. Then if during this time the price of Crude rises above $53.35 (strike price + cost of option at $0.3527 per barrel) your option will return a profit.
In the case you think the price of Crude Oil will be heading south this week then you may buy a Put, this option contract gives you the right to sell Crude Oil at a predetermined price within a certain expiry. The example below shows a Put option with strike at $51.00 and expiry in 2 days for 100 barrels, for a cost $26.08. If the market during this time were to fall below $50.74 (strike minus cost of option per barrel $0.2608) then the option will return a profit.
If you are unsure on direction but expect the price of oil to become more volatile, either moving significantly higher or lower, you may trade this with an option strategy known as a long straddle.
The long straddle involves buying a Call and a Put at the same time, each option has the same strike rate and expiry date. If the price of oil rises the Call option becomes more profitable and if the price of oil falls the Put option becomes more profitable.
For example, the image below shows a Call and Put with strike rate $52.00, to expire in 2-days and for an amount of 100 barrels. The total cost, to buy both options simultaneously, is around $135.
The cost to buy the options is your maximum risk but what is your profit potential? You may make a profit if oil price rises or if oil price falls, but the price must move significantly because you are trading an increase in volatility. As long as the market moves above $53.35 (strike price plus $1.35, the cost of option per barrel) or as long as the market moves below $50.65 (strike price minus $1.35) by expiry, then you will be in profit.
Furthermore, profit will be at 100% if the market falls to $49.31 or rises to $54.69. On the other-hand, if the price of oil does not move out of the range $50.65 - $53.35 then the option strategy will make a loss, this loss is limited to $135 (the cost to enter the option position). The Scenario chart and table below shows this positions profit or loss, at expiry, over a range of WTI OIL prices
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