Mexico driving put skew in Brent

Discussion in 'Commodity Futures' started by J-Law, Aug 6, 2011.

  1. J-Law


    There was an article on yesterday saying Mexico's national oil company, PEMEX,
    Was driving the skew in puts on the Brent contract.

    Personally, I think it's the market responding to the crappy economic fundies across the globe and alike. But, here's a hedging question. Why would a firm put on such an expensive hedge using bid up put options with increased IV instead of doing something synthetic?
    If a put is a call & a call is a put, based on your position long or short in the underlying.Why not just buy the cheaper call options ( Remember the skew is in the puts, making calls cheaper) and then just sell futures (liquid) against them?
    A plain jane synthetic put. Especially given how illiquid listed Brent options are?
    Why pay up for the hedge?

    Just an idle thought...
  2. heech


    There is no "put/call" skew, there is a protect against prices going up and protect against prices going down skew. The conversion/parity trade you referred to is used everyday to keep puts/calls priced correctly at the SAME strike.

    However a "put" skew means strikes under current price (insurance against prices falling) is more expensive than strikes above current price. Producers like Mexico want to be protected against moves to the downside, without losing exposure to the upside. There's no way to eliminate the resulting skew.
  3. Because the calls are also expensive. Same-strike p/c vols trade equal, otherwise you could simply sell futures, buy the call and sell the put for a ~riskless reversal. They could go otm on the long call and short futures to save some bp, but then they're going itm on the synthetic which is obviously more costly in notional-terms.

    My only Brent experience is in digitals/exotics, so I am not familiar with the shape of the smile in the product.
  4. heech


    If you look on BB, WTI and Brent historical iv are basically identical. I assume the while curve is likely a match.

    Put skew has been in place since the release from the petroleum reserve. In the months before that, there was a HUGE call skew as consumers were the ones desperately hedging against surges as North Africa went into chaos.
  5. OK, I assumed as much as they would arb it away with the switch. I had been selling WTI calls lightly over the past few months and noticed the WTI skew had inverted, which is why I stopped.
  6. J-Law


    Atticus, meaning that if there is no pronounced skew in the WTI calls, being short call premium does not make for a favorable trade?
  7. heech


    I'm sure he means it wasn't favorable to him, rather than a generic statement.

    I sell delta neutral calls/puts, around 200-380 contracts a month in WTI. And I've kept it up generally throughout the course of the year regardless of skew... minus moments of complete anarchy, like now.
  8. J-Law



    Just checking back in.

    Looks like selling the calls in WTI was quite the trade over the course of this down leg.

    I wonder if this trade might be still viable especially after yesterday's multi handle rally.
    But got the sense that this down leg is a little long in tooth. Don't think front month spread is much good of a predictor. Whole month of sept spread drifted higher.

  9. heech


    I haven't followed open interest, so I'm not sure whether there has been a lot of call selling. But really, calls implied vola remained largely at historical averages recently (35-40). I think the primary dynamic has been put buying that really pushed implied vola up to 60.

    We will probably stay around 45 implied vola at present levels.... Don't see a lot of people rushing out to sell vola. If prices drop to 75, IV will be back over 50 again.
  10. Imagine if the drug cartels got involved in trading Crude. LOL
    It'd be a whole different ballgame.
    #10     Oct 6, 2011