Hedge funds are quietly laying new bets on a potential spike in oil prices tied to the possibility of an Israeli attack on Iran, skewing the options market to a bullish bias for the first time in six months.
Signs that Israel is losing patience with efforts to curtail Iran's nuclear program, as well as the intensifying conflict in Syria, are giving funds new reason to bet on crude despite a lack of evidence that fundamentals are improving. Activity is muted so far by the summer lull, but could pick up in September.
The renewed premium has been most apparent in futures markets, with benchmark ICE Brent crude gaining 10 per cent over the past two weeks. At the same time, hedge funds boosted their bullish bets in US oil markets a week ago to the highest since early May, regulatory data shows.
“The rally you're seeing now is not because demand is up, but because fear is up,” said Charles Gradante, co-founder of New York's Hennessee Group, which invests with hedge funds.
“Some hedge fund managers feel the fundamentals of oil are still negative and the price should go back down, so they're shorting or trying to short. But the majority are net long, waiting for the next shoe to drop in the Middle East.”
A flurry of comments by Israeli officials and Israeli media reports over the past week put financial markets on edge by appearing to suggest a strike on Iran could be launched before the US presidential election in November.
While US Defense Secretary Leon Panetta and Israeli President Shimon Peres have sought to downplay the risk of an imminent unilateral attack, some funds are on guard.
In the US crude oil options market, calls are being bid higher than puts for the first time since February, indicating that demand to buy contracts that would gain from rising prices (calls) is exceeding that to take bearish bets (puts).
Not as panicked
So far the bets appear to be more modest than they were last November, when funds loaded up on cheap options after a United Nations report heightened concerns over Iran's nuclear program, or in February and March, when talk of a possible attack by Israel on Iran drove Brent above $125 a barrel.
Those bets failed to pay off: instead of an attack, tougher US and European Union sanctions slowly cut off half of Iran's oil exports, and options volatility slumped.
“We’ve definitely seen an uptick in upside call buying,” said one senior trader at a large investment bank. "It's not as panicked or vociferous as it was last time because the bluff has been called once -- and because it's August."
But some are trying it again. Open interest in December 2012 $100 call options has risen by nearly 5,000 lots -- or 5 million barrels -- in the past two weeks.
“Given the implementation of the Iran embargo, we have crimped supply enough to add some real upside risk potential that could easily manifest itself in a price spike, especially if a conflict in the Middle East is realised,” said Chris Thorpe, executive director of energy derivatives at INTL FC Stone. “There is some fear baked in, for sure.”
Long odds
To be sure, these are still long-odds events, and broader market gauges aren't flashing red yet. Absolute option volatility levels are low with calls and puts at around 30 per cent, just up from near-record lows under 25 per cent in early May, according to Reuters calculations.
And some say that barring a wider regional war, the main event over the next month or so will be the possibility of further quantitative easing from the US Federal Reserve.
