Somehow, someway, the Organization of Petroleum Exporting Countries (OPEC) came together in Vienna at the end of November 2016 and struck a deal to cut global crude oil production by 1.2 million barrels per day.
It was the first such deal announced by the group in eight years.
Overcoming a complex web of political and economic differences, the oil cartel pieced together an agreement that cut back or froze production for most member countries starting in January 2017.
Not surprisingly, spot prices for crude oil spiked immediately in the aftermath of the negotiations - with Brent and WTI both up roughly 10% when the dust finally settled on November 30th.
The impact on the overall energy sector was even more astounding, with many stocks levered to the price of oil popping as much as 30% in a single day.
Crude oil has of course frequently been in the headlines since it first plummeted below $100/barrel in 2014 and effectively pulled down the rest of global markets along with it.
At the start of 2016 West Texas Intermediate (WTI) prices fell beneath $30/barrel and traders were deeply unsettled by the prospect that it could break $20.
Fortunately (or unfortunately, depending on your position) prices reversed in February and have been trending higher throughout the year - as have broader market indices (maybe not coincidentally).
Looking at the OVX (CBOE Crude Oil Volatility Index) it's easy to see that markets were expecting a big move after the OPEC meeting on November 30th.
In the nine days prior to the announcement, the OVX (basically the VIX of crude oil) steadily increased by a total of about 22% over that period. On the day before the meeting, the OVX reached 55, its highest level in six months (but still well below the 70+ it notched in February).
Fast forward to December 2nd (two days after the meeting) and the OVX was 35 and change - down roughly 36% in 2 days.
This sample of data indicates that Crude Oil and the OVX appear to behave much like the S&P 500 and the VIX, meaning they are both inversely correlated.
For volatility traders in the energy sector, the OVX therefore seems to be a useful indicator of sentiment and may also be helpful in guiding portfolio management decisions, depending on your strategic approach and risk profile.
Going forward, there are still plenty of developments to follow relating to the oil patch. On December 9th, Russia is scheduled to announce their intention to cut supply along with OPEC, which could also affect crude oil prices (especially if they surprise the market and decline to do so).
After that, it will be important to watch the weekly inventory numbers during 2017 to try and gauge whether OPEC's planned cuts are materially affecting the global demand-supply balance.
Just like a canary in a coal mine, any spike in the OVX may indicate that impacting news is around the corner, that the OPEC cuts aren't having the intended effect, or that demand has increased/decreased in a meaningful way.
In the meantime, if you want to learn more about energy-related volatility trading, the following links covering trades in XOP (SPDR S&P Oil & Gas Exploration and Production ETF) and OVX (CBOE Crude Oil Volatility Index) may be of interest:
If you have any questions on any of the topics covered in this post we hope you’ll reach out at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.