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Schork Oil Outlook: Follow the Money

Over the last month implied volatility in the oil market, as measured by the CBOE’s oil volatility index (OVX), had trended steadily lower. The reduction in the costs of uncertainty, as it were, is a function of the one-sidedness of the bullish trend over this period.

As written in today’s issue of The Schork Report, the OVX has spiked twice thus far this year, first on concerns related to the risk of “contagion” in the Middle East back in February, then again in early May when a mini-bubble (a bubble that was ignited by the aforementioned geopolitical risks in the Middle East) imploded.

For instance, the OVX gained 4.7 percentage points in the second half of February as political violence in Egypt and Libya rose. The OVX then moved lower in March and April as oil prices spiked; i.e. as Nymex oil rose from the mid $80s to the mid $110s, the OVX dropped from an average of 35.9% in the second half of February to a 30.4% average in the last half of April.

This cycle was then repeated in early May. Over a five day period ended May 11th, the OVX surged by 10.7 percentage points (from 31.2% for the five days ended May 04th to 41.9%) as Nymex oil crashed from the mid $110s, back into the mid $90s.

This begs the question, why did oil prices crash in early May?

The news cycle was replete with reasons to explain the February spike in the OVX. However, outside of some prominent energy hedge funds reportedly getting caught long the market, the May spike in the OVX was noticeably devoid of headlines.

This now brings us to last month’s announcement by the IEA to add 60 MMbbls of oil to the market. This event created an immediate and sharp selloff in oil prices, but because oil prices were already trending lower, the OVX failed to react. In fact, it was not until two weeks later, when it was apparent IEA bears had trapped themselves, that the OVX began moving higher.

Now, let’s go back to the OVX spike in early May. As the IEA began to administer damage control shortly after it announced its blatant attempt to fix oil prices, it was announced that the IEA began drawing up a plan for an oil release in… early May.

Bottom line, six weeks after the fact, everyone in the market got the headline to explain the sharp selloff in oil and the corresponding spike in the OVX.

The only question now is… who in the market was privy to that headline back in the first week of May?

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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.