SINGAPORE: A drop in US crude oil implied volatility to its lowest since the financial crisis reached fever pitch last October may suggest that oil traders are beginning to see $50 as a possible point of equilibrium. And while historical volatility has also fallen from its peaks, the decline in implied volatility may say as much about the growing appetite for financial risk-taking as it does about expectations of the future volatility of oil prices. The 30-day at-the-money implied volatility for US crude, which measures the expected movement in oil prices based on options premiums, fell this week to around 68 percent. While still high compared with historical norms of around 35 to 45 percent that prevailed prior to last summer s dive, this is down sharply from a peak above 100 percent in December, a hint of calm in an oil market that has been whipsawed from last July s $147 record high to the five-year low near $32 in December. Now, say some traders, market risks appear more symmetric than any time in recent months, with the prospect of gains limited by global crude oil stocks that remain high by historical standards, while OPEC s resolve and an influx of financial money seeking risk assets seems to have limited the downside. Expectations of the market rising much further are limited given the inventory levels, but with OPEC compliance the downside potential is not great, said Roberto Tassinari, a trader at Saxon Financials in Singapore. I doubt WTI can trade much above $60. Previous periods of reprieve have been short-lived. Implied volatility last fell below 70 percent in early February, when US crude oil tumbled to the low-$30s. Oil then embarked on a 50 percent surge to top $50 a barrel last week, briefly causing volatility expectations to spike. In the futures market itself, historical volatility based on daily price changes on a 22-day basis stands at around 89 percent, also sharply down from its peaks but still above a low of under 80 percent in February. In the stock market, Wall Street s fear gauge - the VIX volatility index - remains in the 40-50 percent channel it has occupied since January, at least double pre-crisis norms but also half its peak touched last November. Easing Risk Implied oil volatility peaked in December at above 100 percent, just as oil prices were attempting to find a floor and as economists were scrambling to gauge the depth of the recession that appeared to be deepening by the day. With the volume of gloomy indicators easing, and some signs of hope emerging, more stability is being factored in. What s happening is that the front month has stabilized, the front of the curve has come up above $50 and stayed there for a while, all because we see a little bit of light at the end of the tunnel on the economic situation, said Tony Nunan, risk manager at Mitsubishi Corp in Tokyo. But analysts also say the gradual return of risk capital to financial markets - including oil - may be helping to put a lid on options prices, which surged when liquidity dried up and major players including Wall Street banks stepped back from the market. Implied volatility is based on the supply and demand for options, and one of the things that happened in the fourth quarter is that nobody wanted any risk, said one analyst at an investment bank who declined to be named. This is telling us that there s been a little bit of an easing in risk aversion, although people still want to be paid quite a bit of money to take that risk on their books.
