Bloomberg recently reported that commodities are getting sucked into a global short volatility trade. But what does that mean – and how can you capitalize? Here are my thoughts, explains Eoin Treacy, editor of Fuller Treacy Money.
This is a section of the Bloomberg article:
“Low macro volatility is definitely contributing to lower implied volatility in oil, but the fact that prices have been rangebound over the past few weeks is likely the strongest reason for it,” said Anurag Maheshwari, head of oil options at Optiver. “Systematic volatility selling strategies have also dominated the flow.”
One of the biggest lessons from my chart seminars is that inside a range, expectations for future potential decline. Ranges are boring relative to the trending phase of a trend. That means volatility strategies stop working and traders have to adapt.
Selling volatility is a symptom of having a short-term time horizon. You would only do that because your expectation for future volatility has been influenced by the absence of volatility in the short term.
This pattern of behavior contributes to the tendency of inert periods of trading leading to explosive breakouts. As short volatility positions are unwound, they fuel the breakout by creating new demand. That’s exactly what happened in copper and brent crude oil this week.
Natural gas also rebounded to post a higher reaction low. That suggests support building is underway. Natural rubber is one of the few quoted in Yen, but it too is breaking out of a decade-long base formation.
The CRB Index peaked in 2022 and has been in a range for much of the last year. It has unwound the overextension relative to the 1,000-day MA and is now firming. A clear downward dynamic will be required to check the potential for a further recovery.
The clear conclusion from the action I mentioned is that we should be prepared for the possibility of commodity price inflation becoming a headline-grabbing story over the next couple of months.
