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Mean reversion in the oil market?


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Mean reversion in the oil market?

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  #1 (permalink)
Pittsburgh PA
 
 
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I have a futures account with Phillip Capital. My position is mildly bullish, with the main feature of being long the Dec 2020 futures contracts and being short the 2019 and 2020 Dec. 150 calls. The risk management person at Phlllip told me that I am betting on "mean reversion", implying that was a bad thing to do, and suggested that I reduce my bet even though I currently have plenty of excess margin (over 90K excess on an account with a liquidating value of about 165K as I write this). Any thoughts or suggestions?

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  #3 (permalink)
Legendary Market Wizard
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a) No idea what he is talking about. "Mean Reversion" is a concept that prices revert to a long term mean over time. Just like prices can't stay at $30 for too long (oil producers going out of business creating a shortage of supply) the can't stay at $150 long either (people drill more wells creating more supply) but when your at $60 what does he think the mean is?

b) You did say you are long Dec20 futures and short Dec19 $150 Calls and Dec20 $150 Calls against it correct? If so do you mind me asking why you would sell those calls for pennies?

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  #4 (permalink)
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USS Liberty View Post
I currently have plenty of excess margin (over 90K excess on an account with a liquidating value of about 165K as I write this)

Hmmm. Liquidating Value $165k minus $90k excess margin, means $75k in margin being used, which would equate to a 30+ lot position?

USS Liberty View Post
My position is mildly bullish, with the main feature of being long the Dec 2020 futures contracts and being short the 2019 and 2020 Dec. 150 calls.

So what does a serious bullish positions look like?

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  #5 (permalink)
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SMCJB View Post
a) No idea what he is talking about. "Mean Reversion" is a concept that prices revert to a long term mean over time. Just like prices can't stay at $30 for too long (oil producers going out of business creating a shortage of supply) the can't stay at $150 long either (people drill more wells creating more supply) but when your at $60 what does he think the mean is?

b) You did say you are long Dec20 futures and short Dec19 $150 Calls and Dec20 $150 Calls against it correct? If so do you mind me asking why you would sell those calls for pennies?

My average at the time I shorted them was about $90 per option (0.09) for the Dec20 $150 calls and about $40 per option (0.04) for the Dec19 $150 calls. I thought it was a good deal because I noticed that the ratio of margin required to premium obtained was much more favorable with those 150 strike price options as compared to options near the money. Yes, you're getting only pennies for those calls but you need to put up only pennies for the margin.

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  #6 (permalink)
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SMCJB View Post
So what does a serious bullish positions look like?

My position would be more bullish if I did not have those short calls (over a thousand total).

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  #7 (permalink)
Market Wizard
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USS Liberty View Post
My position would be more bullish if I did not have those short calls (over a thousand total).

I suggest to check what happens to these FOTM options in case of a severe rise of volatility after an unforeseen event, eg. an attack on an oil pipeline or a war in middle east. These events can happen during the weekend, and on Monday your options have doubled or tripled in value. Or more.

Best regards, Myrrdin

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  #8 (permalink)
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It sounds like you have some fairly large positions to be asking these questions. I would second using option modeling software to see what happens under various circumstances. I would confirm liquidation procedures, as well. I would additionally request additional information from whoever told you this and ask about the particular scenario they envision. I only know basic options but sounds like you have something similar to covered call strategy. I imagine risk could be to the downside, without any puts to protect your futures long, and also potential volatility and liquidation risks.


USS Liberty View Post
I have a futures account with Phillip Capital. My position is mildly bullish, with the main feature of being long the Dec 2020 futures contracts and being short the 2019 and 2020 Dec. 150 calls. The risk management person at Phlllip told me that I am betting on "mean reversion", implying that was a bad thing to do, and suggested that I reduce my bet even though I currently have plenty of excess margin (over 90K excess on an account with a liquidating value of about 165K as I write this). Any thoughts or suggestions?


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  #9 (permalink)
Legendary Market Wizard
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myrrdin View Post
I suggest to check what happens to these FOTM options in case of a severe rise of volatility after an unforeseen event, eg. an attack on an oil pipeline or a war in middle east. These events can happen during the weekend, and on Monday your options have doubled or tripled in value. Or more.

Best regards, Myrrdin

I agree with @myrrdin but would also add that you need to be aware of the margin requirement potential is. We might never get close to $150 but you could get in a position where your forced to liquidate the position due to margin requirements. Of course if your long enough futures the profit on those could easily be large enough to offset that.


tpredictor View Post
I only know basic options but sounds like you have something similar to covered call strategy. I imagine risk could be to the downside, without any puts to protect your futures long, and also potential volatility and liquidation risks.

Sounds like he's short a lot more calls than he is long futures, so it's going to behave more like an uneven straddle how uneven will depend upon the ratio of calls to futures.
Long 1 Future, Short 1 $150 Call = Covered Call = Short 1 $150 Put
Long 1 Future, Short 2 $150 Calls = Short Put + Short Call = Short 1 $150 Straddle
Long 1 Future, Short 3 $150 Calls = Short Put + Short 2 Calls = Short 1 $150 Straddle + Short 1 $150 Call

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  #10 (permalink)
Legendary Market Wizard
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USS Liberty View Post
My average at the time I shorted them was about $90 per option (0.09) for the Dec20 $150 calls and about $40 per option (0.04) for the Dec19 $150 calls. I thought it was a good deal because I noticed that the ratio of margin required to premium obtained was much more favorable with those 150 strike price options as compared to options near the money. Yes, you're getting only pennies for those calls but you need to put up only pennies for the margin.

I'm guessing this has worked out for you big time? Up over $10/barrel on your futures, offset by a couple of pennies on the calls?

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