Crude Awakening: Geopolitical Tensions Ignite Oil Market Frenzy

The Middle East's escalating tensions have sparked a surge in bullish bets on oil futures, with traders scrambling to position themselves for a potential price spike. The options market, in particular, has seen a frenzy of activity as investors seek to hedge against the risk of supply disruptions.

Volatility Soars as Traders Brace for Potential Shocks

Reversing Bearish Bets

In a dramatic turnaround, hedge funds, commodity trading advisors, and other money managers have raced to reverse their previously bearish positions on crude oil. Just a few weeks ago, traders were paying up for bearish options as concerns over slowing economic growth and increased OPEC+ production weighed on the market. However, the escalation in the Middle East has completely changed the landscape.Traders who had previously sold calls are now looking to buy them back, seeking to protect themselves against a potential surge in prices. The call skew on second-month West Texas Intermediate futures has jumped to the highest level since March 2022, when Russia's invasion of Ukraine sparked fears of a major supply disruption.

Surging Volatility and Demand for Upside Exposure

The increased demand for upside protection has driven a significant rise in implied volatility, which has now surpassed a high from October of last year. According to Anurag Maheshwari, head of oil options at Optiver, "We have seen a sizeable bid in volatility and increased demand for upside exposure to oil prices. This escalation is potentially more impactful on oil supplies."Last week, traders snapped up December calls on Brent crude, betting on oil reaching $100 or higher. The aggregate call volume hit a record on Wednesday, as WTI futures surged as much as 11% amid concerns that Israel might strike oil facilities in retaliation for Iran's missile attack, raising fears of a Middle East supply disruption.

Bullish Shift in Positioning

The bullish sentiment has extended beyond the options market and into the futures market as well. Money managers' net long positions in Brent crude jumped by more than 20,000 contracts in the week through Oct. 1, according to ICE Futures Europe data. This bullish shift started in earnest after China announced a massive stimulus package to bolster its economy, further fueling the market's optimism.Carley Garner, senior strategist and founder at DeCarley Trading, noted that "Option traders had given up on the idea of a rally, leaving the implied volatility in oil call options near multiyear lows. In essence, the market was unprepared for the surprise, and we are seeing FOMO (fear of missing out) now that prices are finally moving in favor of the bulls."

Outlandish Bets on the Futures Curve

The bullish sentiment has also manifested in the futures curve, with traders snapping up outlandish bets on the structure rallying heavily. More than 5 million barrels wagering on the nearest Brent spread hitting $3 a barrel traded last week, a significant increase from the 62 cents level on Friday.The stress on the market was most evident in short-dated contracts, with the term structure for 25-delta options showing a spike in bullish trading in recent days. Implied volatility for December calls climbed more than 30 points last week, more than triple the increase for puts, while there was almost no change for either bullish or bearish positions for July contracts and onward.

Producers Lagging Behind

The bullishness for the commodity, both on Brent and WTI, has exceeded that for producers, who are likely to see a benefit only if prices remain higher for longer. Volatility and call skew in one-month options on the US Oil Fund LP exchange-traded fund both surged more than for the SPDR S&P Oil & Gas Exploration & Production ETF, indicating that the market's enthusiasm is primarily focused on the underlying commodity rather than the equities of the producers.Rebecca Babin, senior equity trader at CIBC Private Wealth Group, noted that "The escalation in the Middle East has sparked a massive amount of short covering in crude oil as CTAs have flipped from short to neutral. Fundamental energy investors remain fairly sour on 2025 and are using call options as opposed to chasing the rally in crude to get upside exposure to a potential supply disruption."