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(Bloomberg) — Oil’s early-August pop in volatility has been quickly reversed, with the $75-a-barrel price level once again proving to be a sticking point for the Brent market.
The short-lived increase came as volatility in equities and other markets spiked suddenly. The broader risk asset sell off came amid concern that the Federal Reserve was waiting too long to ease interest rates and would cause the economy to overcorrect, crimping oil demand.
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Now, with conflict between Israel and Hezbollah heating up, equities rallying as the Fed signals it’s ready to cut rates and the physical oil market showing some signs of near-term supply tightness, Brent prices are climbing back into the middle of the $75 to $90 range they’ve mostly held in since November. Barring a sharp escalation in the Middle East, those factors are set to put pressure on option values, which have tended to rise when futures threaten to fall below the range.
Brent and West Texas intermediate crudes both rose about 0.5% in early Asia trading Monday.
Whether volatility remains low may also depend on if OPEC+ countries follow their provisional plan to reverse some of their supply cuts in the coming months. If they boost output, stockpiles may build in the fourth quarter, according to Trafigura Group. That would likely weigh on prices, potentially stoking more demand for options protection.
Implied volatility on second-month contracts sank Friday to the lowest since July 29, a sharp reversal from a six-month high reached a couple weeks earlier. Meanwhile, the put skew late Friday steepened to the largest since December.
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The skew has steepened in favor of puts, which suggests investors see a lower risk of oil prices spiking higher, according to Tanvir Sandhu, Bloomberg Intelligence Chief Derivatives Strategist. Concerns about stagnant demand growth are balanced against geopolitical risks. That may result in smaller price swings, as seen prior to August when volatility reached multi-year lows.
There are some signs of near-term supply tightness. US stockpiles have fallen almost 35 million barrels over the past two months. The biggest increase in options open interest over the past week came from November calls from the upper $80s to $100.
“Very prompt oil is tighter than many thought it would be, and the market is short,” said Scott Shelton, an energy specialist at TP ICAP Group Plc.
—With assistance from Devika Krishna Kumar.
(Updates with early Monday trading in fourth paragraph)
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