Friday, September 28, 2007
Brent over 82 $
Yesterday Brent crude price jumped 4 $ (5%) for no reason at all, except that American economy was shown booming, unharmed by high oil prices. Krichene studied the 2006 dynamics of crude prices (Available at SSRN: http://ssrn.com/abstract=956763) and found that oil demand pressure kept increasing during this period, causing oil prices to rise by more than threefold, from US$21.13/bl on January, 2002 to US$73.76/bl on July, 7, 2006.4 Second, the noted ascent in oil prices was not monotonic or smooth; oil prices rose, often to a new record, retreated temporarily, then resumed their move to higher record; their movements were dominated by high intensity jumps, indicating that oil markets were constantly out-of-equilibrium. Third, oil price volatilities were excessively high. Measured by the implied volatility, volatility was in the range of 30 percent, implying that oil markets were facing big uncertainties regarding future price developments and were sensitive to small shocks and to news. Finally, market expectations, extracted from crude oil call and put option prices, were right-skewed. More specifically, markets held higher probabilities for further price increases than price decreases. Moreover, markets seemed to expect large upward jumps in oil prices, as reflected by the price and volume of options at strikes in the range of US$75–US$85/bl. When modeled as a jump-diffusion (J-D) process, oil price dynamics were dominated by the discontinuous Poisson jump component compared to the continuous Gaussian diffusion component, showing that oil markets were constantly out-of-equilibrium during the sample period and were sensitive to demand and supply shocks and to news.
The bottom line is that the market is out of equilibrium with strong tendencies to higher oil prices. Now what with my PUT options? A small disequilibrium of temporary overproduction or momentary fall in demand may collapse prices. So I hope.