The Spark

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There's more—or maybe, less—to the latest panicky oil bottom than meets the eye.

The sharp downward move Wednesday, which at one point dragged the Dow Jones Industrial Average lower by more than 550 points, has been called by at least one market strategist a "mirage." Oil industry sources agreed the activity was somewhat unusual.

Here's what happened.

On Wednesday, the benchmark U.S. oil contract fell almost 7%, whacking the stock market broadly and in particular energy companies like Exxon, Chevron, and ConocoPhillips.

The steepest selling pressure occurred roughly around 1 p.m. Eastern time. The February WTI contract went on to close at 2:30 p.m. Eastern on the New York Mercantile Exchange down $1.91 to $26.55 a barrel, the lowest settlement for a front-month contract since 2003. The February contract then expired.

Enter the March contract, which the benchmark oil price flashing around the world now began to track.

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The price of oil, remember, like other commodities, is not typically quoted from cash markets but rather from futures to allow for smoother and more comparable tracking of the commodity's value over time. That means, however, that the quoted price has to "roll over" from the nearest month's contract to the following month's contract as each new month approaches.

When this happened on Wednesday, the price of oil rebounded.

The March contract began trading at closer to $28 a barrel. The stock market saw this as a rally, and rebounded off the deep lows of the session to see the Dow close lower by only 249 points. The Nasdaq Composite index nearly finished positive on the day.

"We dodged a bullet here," said Arthur Cashin, director of floor operations for UBS, on "Closing Bell" Wednesday, referring to oil's bounce off the lows that spurred the stock market's comeback. The comeback, he said, helped avoid triggering a classic "Dow Theory" sell signal, which happens when the Dow transports, utilities, and industrials simultaneously hit 52-week lows.

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Indeed, midday Wednesday, many unnerved investors and strategists were close to panic.

Brian Reynolds, the chief market strategist at New Albion Partners, was one of the many concerned—until he took a closer look at the oil price action.

The March contract never took quite the beating that February's did on Wednesday. He found that odd.

After all, the hand-off from one contract to the next each month should be relatively seamless. And if anything, investors and corporate players would already have moved on to the more liquid March contract, which never traded as low as February's did. Indeed, volume in the February contract had dwindled; anyone left in it upon settlement would suddenly either owe delivery or have to take delivery of physical barrels of oil.

As a result, the world was focused on an oil contract in which there was very little volume, and whose price was plunging while the more heavily-traded March contract was not.

"So, some part of yesterday's stock market plunge was based on a mirage, intentional or not," Reynolds wrote in a client note Thursday.

It's possible that some investors realized the intense correlation between the oil price and the stock market and zeroed in on a thinly traded contract to intentionally move its price on Wednesday.

In any case, it's not the first time such a gap has been recorded of late. There have been five times since the start of 2014 that the gap between the two contracts on settlement day has been at least $1, according to Chicago Mercantile Exchange data in the Platts database.

That said, the correlation between the price of oil and the price of stocks has intensified this year, to a whopping 96 percent.

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"These are more tied than I've ever seen them in the 25 years I've been trading oil," said Anthony Grisanti, president of GRZ Energy.

Anyone, therefore, who noticed the disparity between the two oil contracts was presented with a great buying or short-covering opportunity on Wednesday.

As to whether the stock market has put in a "real" bottom, Reynolds said he would like to see corroborating evidence of improving conditions, like the yield on the 10-year U.S. Treasury note moving back up, and improvement in the investment-grade corporate credit market.

In the meantime, investors would benefit by taking the broadest possible view of oil prices—particularly on settlement days.