Several hours before the US stock market opened on Monday, the commodity world was shaken by an unexpected surge in crude options trades, with traders noting that “someone is either moving positions, blown up or getting out of commodities. MASSIVE amount of blocks going through in crude options.“
— Mark Scullion (@mscullion) July 24, 2017
A Bloomberg alert shortly after confirmed the huge size of trades crossing the tape, when nearly $100 million in oil options traded simultaneously:
WTI crude oil options traded the equivalent of 48m bbl of contracts via block, according to data compiled by Bloomberg.
- Total value of all options combined is ~$99m
- Options include contracts from September 2017 through December 2020
- 5 largest blocks were: 4.4k Dec. $90 calls, 2.8k Dec. $60 calls, 2.5k Dec. $125 calls, 1.7k Dec. $95 calls, 1.4k Dec. $46 calls
- Click here for Excel detailing the value of each trade
- Trades all took place at 9:35am London time
- Contracts also traded with 9.6k lots of futures
- Similar trades also occurred on Brent in smaller volumes ~10:35am London time
As it turns out later, it wasn’t a fund liquidating, but Barclays selling the last part of its legacy oil book to an unidentified buyer, that triggered the surge in trading of exotic options most of which were written in the era of higher crude prices, Bloomberg reported this afternoon.
The size of the trade, which set traders on alert earlier, represented some 48 million barrels of contracts which “represents more than a quarter of the entire volume on an average trading day.”
Barclays announced that it was exiting its energy trading business altogether last December – which until that point had been housed in its macro-trading unit – when the British bank joined an exodus that analysts then said raised concern among oil producers that falling liquidity means they cannot use derivatives for their basic function: to hedge risk by locking in future prices. As Reuters reported at the time, the departure of Barclays exacerbated the scarcity of counterparties for trade when producers are trying to hedge their production for 2018 and beyond, potentially raising the cost to lock in that output. That increase, analysts speculated, could force some cash-strapped producers to forgo protection altogether, putting them at risk if the market takes another leg down.
One point of uncertainty in December was what Barclays was going to do with its trade book: at the time, analysts pointed out that Barclays could unwind hedges that it already conducted with market participants. The other option would be to sell the hedge book, thereby passing on any risk to another player.
This is precisely what happened on Monday, when Barclays’ transaction marked the final sale of the business.
A look at the derivatives that crossed the tape on Monday “were suggestive of a bygone era of oil prices above $100 a barrel”, Bloomberg wrote. The strike prices for some of the options were far from today’s prices, suggesting they may have been part of deals struck years ago.
Three of the 4 largest trades would profit if crude rises above $90, $95 or $125 a barrel by the end of this year. There were also rarely seen deep “in the money” options on the global benchmark Brent, that would allow the holder to sell crude at $80 a barrel. The contracts ranged from September this year to December 2020.
As Bloomberg concluded, while the transactions are small for Barclays, they’re much more profound for an oil market where banks are increasingly scaling back. Morgan Stanley, JPMorgan Chase & Co. and Deutsche Bank AG all reduced or exited commodities trading over the past several years, while Goldman Sachs Group Inc. was said to be reviewing its activities.
The counterpart(ies) on the Barclays trade remain unidentified.
Perhaps the best news from today’s book sale is that it concluded smoothly and without any major market impact, suggesting it was planned well in advance. The question is what would happen to the oil derivative market if a similarly-sized block hit the tape ad hoc and without prior warning. For the sake of the Fed’s “market stability” mandate, let’s hope we don’t find out.