Commodities Futures Markets Point to More Oil Volatility Ahead at $60 or Below

12/08/2014 8:27 pm EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

Oil prices plunged today as traders who bet that oil was due for a bounce last week took off that bet, and MoneyShow’s Jim Jubak thinks that tracking the cash flows at oil ETFs is one way to track the bullish/bearish sentiment on crude.

It looks like bets on the price of oil in the commodities markets are now driving the price of oil.

Today, for example, we’re seeing oil prices plunge, as traders who had decided last week that oil was due for a bounce, take off that bet.

In the week that ended on December 2, the net long position in West Texas Intermediate on the commodity futures market rose by 14%, according to the US Commodity Futures Trading Commission. Short bets—bets on that oil prices would fall—dropped by 15%.

With the bulls in retreat today—as traders decide that the selloff isn’t over and liquidate their long positions—the price of West Texas Intermediate, the US crude benchmark, has tumbled to $63.02 for January delivery. That’s a drop of $2.82 a barrel or 4.28% on the day. The Brent benchmark is down to $66.14 a barrel, a drop of $2.93 on the day or 4.24%.

Looking at the commodities markets, there’s a big bulge in positions around $60 a barrel and another extreme bet near $40. In the short-term, the direction of oil prices depends on when/whether—at $60—the shorts at that price cover and the longs burned by last week’s bets on a bump decide to step back in.

On a slightly longer horizon, the reaction of the shorts at $35 and $40 comes into play. I suspect that a big portion of the bears betting on $40 oil really don’t see oil going to that price. Rather, they are buying what were once cheap puts as a way to make a profit on rising fear in the oil market.

Think of them as lottery tickets.

Put options purchased in late November had doubled in price by early December. The number of December 2015 options to sell West Texas Intermediate crude at $40 a barrel—an option that would only pay off if crude dropped below $40—quadrupled in the last two weeks of November to 880,000 barrels. Puts with a $35 strike price rose to a level of 669,000 in that period from an earlier zero total.

West Texas Intermediate futures last settled below $40 in February 2009.

Global investment banks such as Deutsche Bank and BNP Paribas currently peg the price-floor at $60 a barrel or less.

Tracking the cash flows at oil ETFs, such as the United States Oil Fund (USO) and ProShares Ultra Bloomberg Crude Oil (UCO) is one way to track bullish/bearish sentiment on crude. In November, investors and traders who figured that oil had hit at least a temporary bottom added $559.9 million to the four largest oil ETFs, according to Bloomberg. The first four days of December brought in another $98 million in cash. (Net assets at United States Oil Fund were $909.5 million as of December 4 and $374.3 million at ProShares Ultra.)

Today, traders have reversed those flows. United States Oil Fund was off 4.21% for the day and ProShares Ultra, which aims for 2 times leverage to price of oil, had plunged 8.24%.

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