trading the curve

jamesmith

Because of recent economic and political changes, crude oil price has been very volatile. There are two big crude oil futures, wti and crude. wti is in contango(because of extra oil needs to be stored at a cost) in near term and backwardation in longer term. One way to trade it is to bet the curve will flatten over time, because oil usage tends to be higher during the summer, extra oil will be used up, thus flattening the curve. We can use a butterfly to trade this scenario, short the spike in middle and long the two sides.



Looking at historical spread of brent and wti, one can notice they are usually near the same price until 2011. oil production from Europe, Africa and the Middle East flowing West tends to be priced relative to this brent. The chaos in Middle East surrounding Iran caused brent price to go higher compared to wti, thus widening the spread. If one believes there will not be a war in the Middle East (US will withdraw troops seems to be a good sign), the spread should be smaller, we can bet on this by going long wti, while shorting brent.





Brent  http://en.wikipedia.org/wiki/Brent_Crude
WTI   http://en.wikipedia.org/wiki/West_Texas_Intermediate

jamesmith

an update on Brent - WTI spread

The One - Two Punch of Lower Oil Prices
TUESDAY, JUNE 12, 2012 AT 12:47PM
Well, maybe 'punch' is not quite the right word, but whatever you want to call it, American consumers are benefitting in two ways from the recent moves in oil prices.  Over the last several weeks, not only have we seen a 20% decline in the price of WTI crude oil, but Brent crude oil prices have been falling even faster.  As we have pointed out in the past, gasoline prices are typically more positively correlated to moves in the price of Brent crude oil.  When WTI crude oil falls faster than Brent, gasoline prices stay elevated.  When Brent falls faster than WTI, gasoline prices fall faster.

The chart below tracks the spread between the price of WTI and Brent crude oil prices over the last year.  The current spread between the two benchmark prices of crude oil stands at $14.05 and is down more than a dollar today alone.  While this is down from the highs we saw last year, it is still elevated by historical standards (prior to 2011 the spread was never really more than a couple of dollars).  Now, if we could only get this spread back to the single digits, Americans could very well see gasoline with a $2 handle once again!