How Expensive Are Oil Options?

Focus: OPTIONS

Jared Woodard Image Jared Woodard Principal, Condor Options

Although crude oil prices have been holding pretty steady, even amidst negative cliff-related news in the media, oil options appear to be significantly overpriced, writes Jared Woodard of CondorOptions.com, and could set up a viable trade opportunity.

WTI crude oil options are priced at a substantial premium above the trailing volatility of the underlying. One-month options using the VIX methodology (OVX) were priced at the Friday close above 24%, while the one-month close-to-close historical volatility of USO was just 14%.

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Fig. 1. USO 1M volatility risk premium. Source: FRED, Condor Options
Click to Enlarge

The distribution of USO volatility risk premium has some fairly extreme values—look at the reading near 3 in late 2011—but the current value of 1.75 is in the top decile of observations since 2007. The obvious assumption is that options are significantly overpriced.

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Fig. 2.