We disseminate a note several mornings a week with 3 bulleted takeaways from derivatives-centric markets. The point is to hash out observed consensus views with our own to 1) Find asymmetric pressure points and 2) Generate non-consensus ideas. Below is a portion of this morning's note contextualizing what the 1-month move in energy has meant for forward expectations. For important context, Keith's Early Look this morning on the inflation read-through is an important complement to the topic below.
----------
Crude Oil Surface Shift – The important thing to remember upfront is that commodity markets often uproot the “down markets = up volatility” framing that normally applies to equity markets. Commodity markets have all of the “supply-shock” narratives – it’s more powerful in some markets than others.
With USO +10.6% m/m and crude oil up +1.2% this morning, OVX looks like it wants to take a peek at a YTD high. It trades at 29.42 this morning against a YTD high of 30.39.
Investors have rapidly shifted their directional expectations and the volatility surface has shifted higher (the LEVEL), and is now is now positively skewed in USO (the DIRECTION). It is more expensive to bet on upside in crude oil than it is to bet on downside – We really haven’t seen a sustained bullish tilt like this since the summer of 2014. The top right chart in the visual below shows the pricing at different strikes (50-delta is at the money).
Relative Sector Skew (XLE) – We use Z-Scores to help us flag trending changes, and the same kind of directional trend we mention above exists in the S&P 500 Energy Sector.
- 1st Chart: The LEVEL of implied volatility is going higher in XLE, which is why we don’t see a major dislocation in implied dispersion. Often you see that when a sector outperforms on declining realized volatility, this will smash forward looking volatility in that sector (recency bias). This hasn’t happened in the Energy sector (think OVX & XLE up).
- 2nd Chart: However, the directional tilt in XLE is the same that we see in USO. Investors have pushed up implied vol in the upside strikes.
