FxWirePro: WTI - Not a long indeed but stay hedged via vertical spread to mitigate WTI vega risks ahead of crude inventory check

Universal fact is that the prevailing supply glut has impacted on drop in oil prices, the commodity continued on their downward trajectory last week and recorded multi-year lows.

WTI crude futures have recently dropped to multi-year lows at $34.53 per barrel which has been its lowest level from last 11-1/2 years.

Oil prices are under considerable pressure and are shedding yesterday's gains again. The prospect of additional oil from the US and Iran reaching the market in early 2016 is weighing on prices.

Overnight, the US Congress agreed to completely abolish the ban on US crude oil exports, which has been in place for 40 years.

Voting on this is yet to take place, after which US President Obama will still have to sign the law.

Having said that, the impact on the market should be limited, for the price differential between Brent and WTI must at least cover the costs of transport by pipeline from the Midwest to the US Gulf Coast for US light oil to be of any interest to international consumers.

This is far from the case at present given that WTI in contracts with maturity dates in February and after is actually priced somewhat higher than Brent.

At present, only contracts due in 2018 would generate a sufficient WTI discount to make it attractive to export US crude oil.

Furthermore, not much will change when the export ban is officially lifted because the US has already been stepping up its crude oil exports in recent months following the gradual easing of the ban.

According to figures from the US Department of Energy, crude oil exports since March have for the most part exceeded 500,000 barrels per day.

Hedging Perspective:

So the recommendation would be "long vertical put spread" that will cuts down the exposure you have against dubious rallies in anyone's mind, but more significantly it will also reduce the exposure you have to Vega, the relative effects of volatility on the option prices.

Hence, you will long on 2W -0.51 delta ATM put option while simultaneously short the 3D -0.15 delta 2.5% OTM put option. Since the premium will be higher for the higher delta versus the lower delta this trade will be established for a net debit.

One way of minimizing the avid appetite with a naked long put has for your precious capital is to spread much of the risk by using vertical spreads.

Hence, we constructed the above strategy by shorting (-2.5%) deep Out-Of-The-Money put with the same maturity so as to turn vega into correspondingly positive.

Rationale: Always remember the option's delta and vega would have the huge impact on a long put position should the market bounce dramatically which seems unlikely.