With the implicit volatility in futures contracts, market participants turn to options contracts as a way to hedge risk. In a perfectly neutral market for a perfectly normal security, put options should have the same value as call options.
In the real world, the market and the underlying security is expected to trend in a certain direction, creating a put/call ratio “skew.” An increasing ratio suggests that traders are concerned about downside risk, and thus willing to pay more for puts, and vice versa for a decreasing ratio.
The chart of the day in today’s issue of The Schork Report considers the put/call skew for crude oil and heating oil. The 50 day moving average (MA) for WTI rose between May and August, over which time the bulls attempted a rally but failed, with the front month ending May at 78.69 and ending August at 76.19. Since then, the skew has been falling.
Conversely, the skew for heating oil has been rising since September 28th i.e. traders became more concerned about heating oil prices. The effect on the crack was clear, it fell almost 20% between the end of September and the end of October. The fact that option skew continues to rise for WTI (the 50 day MA recently crossed above the 200 day MA — a signal of upward trend) and fall for heating oil (the 50 day MA recently crossed below the 200 day MA) places us on the bearish side of the heating oil crack.
Yesterday traders tested and settled below the heating oil crack’s 50 day MA of $13.7001. Analysts at The Schork Reportare looking for further weakness towards the $12.300 low double bottom established in October and below here the 100 day MA of $11.982.
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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.