Oil Traders Turn to Obscure Options Market for Extra Finance

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(Bloomberg) — Some oil traders are tapping the options market to ease the financial pressure caused by soaring margins and volatile crude prices. 

Since war broke out in Ukraine in February there has been a surge in trading of so-called euro-box spreads on West Texas Intermediate. The strategy is similar to a zero coupon bond — a way for sellers to raise cash in the face of limited sources of capital. 

While options traders say it’s a relatively normal part of the market, open interest in such contracts has jumped to the highest level since 2016, underscoring the surge in demand for the trades. With prices spiking and then slumping rapidly after Russia’s invasion, exchanges sharply hiked their margins, boosting the amount of capital needed to keep trading and forcing some to the sidelines. 

Some of the industry’s top traders have flagged the growing cost of staying active in the market in recent weeks. Earlier this month, Shell Plc said it has seen a cash outflow of $7 billion and that it expects continued volatility in cash flow due to margining effects on oil derivatives. Other oil traders including Trafigura were also said to face big margin calls in the immediate aftermath of the war.

About 80% of the open interest in European style WTI options consists of box spreads. The trades involve simultaneously buying or selling identical spreads of bullish call and bearish put spreads, a move that is essentially the same as borrowing funds for the life of the options contract.

The strategy allows traders to collect a premium for selling the deep in-the-money options. This effectively puts cash into their accounts until the options expire and the premium disappears as futures positions are netted out at a loss. That in turn gives them more money and flexibility when having to post margins, which rocketed higher when crude spiked, traders and brokers said. 

In the case of the recent volumes, the gap between the contracts has generally been $100 wide, with $10 and $110 calls and puts trading, as well as $50 and $150 calls and puts. So far about 25 million barrels worth of contracts have traded.  

Some traders also flagged that margin requirements for options can vary by contract or exchange and this strategy works best in WTI options. The CME Group on Monday reduced its WTI margins.

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