NEW YORK - Wild price swings on the U.S. crude oil market have driven a big increase in the use of options as traders seek more sophisticated ways to reduce risk and lock in profits.
Open interest in crude oil options traded on the New York Mercantile Exchange surged 20 percent from the start of the year, surpassing 4.73 million contracts, while open interest in oil futures rose only 3 percent to 1.4 million contracts -- marking a big slowdown in growth.
"A lot of small speculators have been burned by the gyrations in the futures market," said Rob Kuratowski with optionsXpress in Chicago. "Timing is everything with futures and if your timing is wrong, you're going to get stopped out or hit with margin calls."
U.S. crude oil futures have become more volatile since the beginning of 2008 according to Reuters data.
Swings of several percent a day are now common and with oil trading above $100 a barrel, even small moves in percentage terms can trigger margin calls, traders said.
"There's a lot more trade recommendations out there ... and more nontraditional speculators who are looking to cut risk. That's what's pushing up open interest," said Kuratowski.
New trading strategies are also fueling the rapid growth in options open interest as a more liquid options market allows investors to bet on more detailed trading scenarios.
"This is an extension of a long term trend - the options market has been adding market share over the last five years," said Citigroup energy futures analyst Tim Evans.
"We'll continue to see growth in options as traders get more sophisticated. Options are a product that can be tailored to very specific price scenarios. It can easily take three different options positions to replicate one futures position," Evans said.
But while highly speculative options bets on huge moves in the price of crude oil have attracted attention, contracts near the current price of oil are growing even more rapidly.
So-called delta-adjusted open interest, which adjusts the open interest of options positions to reflect a mathematical formula -- delta -- that shows the probability that exercising the options will be profitable, is rising faster than overall open interest.
Delta-adjusted open interest is up over 345,000 contracts or 30 percent since the start of the year according to data from the U.S. Commodity Futures Trading Commission, outpacing the 20 percent overall gain in options positions.
"When markets are volatile like this, you don't want to trade the futures. With the options, you can bet your views without getting hit by the tremendous intraday volatility. You avoid margin calls and being stopped out of your position," said Nauman Barakat, senior vice president at Macquarie Futures USA in New York.
The volatility in oil markets is also allowing professional traders and market makers like investment banks to boost short term profits by selling options, which have risen sharply in price in recent weeks, futures brokers and analysts said.
Options prices tend to rise when the volatility of the underlying security increases, reflecting their increased value of the "insurance" against price swings.
"Even though the options are trading at unusually large premiums because of the volatility, they've attracted a lot of the speculative buying," said Barakat.
The higher prices encourage market makers and speculators to sell options in an effort to capture short-term gains as the price of all options tends to fall as their expiry date nears.
Open interest in crude oil options traded on the New York Mercantile Exchange surged 20 percent from the start of the year, surpassing 4.73 million contracts, while open interest in oil futures rose only 3 percent to 1.4 million contracts -- marking a big slowdown in growth.
"A lot of small speculators have been burned by the gyrations in the futures market," said Rob Kuratowski with optionsXpress in Chicago. "Timing is everything with futures and if your timing is wrong, you're going to get stopped out or hit with margin calls."
U.S. crude oil futures have become more volatile since the beginning of 2008 according to Reuters data.
Swings of several percent a day are now common and with oil trading above $100 a barrel, even small moves in percentage terms can trigger margin calls, traders said.
"There's a lot more trade recommendations out there ... and more nontraditional speculators who are looking to cut risk. That's what's pushing up open interest," said Kuratowski.
New trading strategies are also fueling the rapid growth in options open interest as a more liquid options market allows investors to bet on more detailed trading scenarios.
"This is an extension of a long term trend - the options market has been adding market share over the last five years," said Citigroup energy futures analyst Tim Evans.
"We'll continue to see growth in options as traders get more sophisticated. Options are a product that can be tailored to very specific price scenarios. It can easily take three different options positions to replicate one futures position," Evans said.
But while highly speculative options bets on huge moves in the price of crude oil have attracted attention, contracts near the current price of oil are growing even more rapidly.
So-called delta-adjusted open interest, which adjusts the open interest of options positions to reflect a mathematical formula -- delta -- that shows the probability that exercising the options will be profitable, is rising faster than overall open interest.
Delta-adjusted open interest is up over 345,000 contracts or 30 percent since the start of the year according to data from the U.S. Commodity Futures Trading Commission, outpacing the 20 percent overall gain in options positions.
"When markets are volatile like this, you don't want to trade the futures. With the options, you can bet your views without getting hit by the tremendous intraday volatility. You avoid margin calls and being stopped out of your position," said Nauman Barakat, senior vice president at Macquarie Futures USA in New York.
The volatility in oil markets is also allowing professional traders and market makers like investment banks to boost short term profits by selling options, which have risen sharply in price in recent weeks, futures brokers and analysts said.
Options prices tend to rise when the volatility of the underlying security increases, reflecting their increased value of the "insurance" against price swings.
"Even though the options are trading at unusually large premiums because of the volatility, they've attracted a lot of the speculative buying," said Barakat.
The higher prices encourage market makers and speculators to sell options in an effort to capture short-term gains as the price of all options tends to fall as their expiry date nears.
