December 3, 2015 / 1:08 AM / in 4 years

Expensive oil options point to fear of sudden price move: Kemp

LONDON (Reuters) - Oil options are becoming increasingly expensive as the market waits nervously for the outcome of the OPEC meeting in Vienna and eyes the large concentration of bearish bets by hedge funds.

Pumpjacks taken out of production temporarily stand idle at a Hess site while new wells are fracked near Williston, North Dakota November 12, 2014. REUTERS/Andrew Cullen

Most oil analysts and investors expect OPEC will leave its production target unchanged at 30 million barrels per day or even increase it slightly to accommodate the return of Indonesia to membership.

But hedge funds have already amassed a near-record short position of almost 300 million barrels in Brent and WTI futures and options betting on a further drop in crude prices.

If the outcome of the meeting is not thought to be in doubt there is considerable uncertainty about how the market will react afterwards.

If ministers leave production unchanged it could give hedge funds a signal prices will fall further, sending the market into a tailspin below $40 per barrel.

But if prices do not fall as expected, there is a strong chance the market will rally, perhaps sharply, as hedge funds book profits and trim their positions.

And in the unlikely event oil ministers cut production, the large number of short positions could result in a very brutal short-covering rally.

The large concentration of short positions held by hedge funds has introduced a high degree of uncertainty into the short-term outlook for oil prices.

In 2015, large hedge fund short positions in Brent and WTI have presaged sudden price moves and an upsurge in volatility.

The only other time hedge funds have held a short position this large, in mid- and late August, it preceded a brutal short covering rally, which saw prices surge $11 per barrel, or 25 percent, in just three trading days.

Option prices are directly related to traders’ estimates of the probability of sharp price moves in the future, technically known as implied volatility.

Implied volatility for Brent options has been steadily increasing since the middle of October as the market reacts to the big build up of hedge fund short positions and the imminent OPEC meeting.

Implied vol for at-the-money Brent options has climbed from 34.5 percent in mid-October to 44 percent at the start of December and is at the highest level since the price spike in August (tmsnrt.rs/1NHlo8P).

The average or median level of implied volatility since 2006 has been just under 31 percent.

Implied volatility is currently in the 86th percentile for all trading days since 2006 - in other words implied volatility has only been higher than it is at present 14 percent of the time (tmsnrt.rs/1NHnoxR).

The fact implied vol is almost 1.5 times higher than normal indicates traders see a relatively high risk of large price moves in the near future.

(John Kemp is a Reuters market analyst. The views expressed are his own)

Editing by David Evans

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