Oil war volatility pushes investors toward complex 'hybrid' options bets

[Oil barrels on gold bullions background. 3d illustration]
Rawf8/iStock via Getty Images

The sharp swings in oil prices since the war involving Iran began have shaken financial markets and pushed some large investors to experiment with complex derivatives designed to bet on how different assets move relative to each other, Bloomberg News reported Sunday.

Oil prices have been especially volatile. On March 9, crude traded in a range of nearly $36 a barrel in a single day, the largest intraday swing ever recorded. That volatility quickly spread to other markets including stocks, bonds, gold and currencies.

For ordinary investors, markets usually follow some predictable patterns. When economic risks rise, money often flows into so-called “safe haven” assets such as government bonds or gold. But that pattern has recently broken down. Oil prices have surged while some traditional defensive assets have also fallen, creating confusion about where investors should seek protection.

Part of the reason is concern about inflation. If shipping through the Strait of Hormuz remains disrupted, the effect would reach far beyond oil. Higher energy costs can ripple through industries that rely on fuel or petroleum products, including plastics, fertilizer, metals and natural gas.

That possibility has revived fears of stagflation, a scenario where economic growth slows while prices continue rising.

To navigate these unusual market moves, some professional investors are turning to hybrid options, a type of derivative that links the performance of two or more assets.

For example, a hybrid trade might pay off only if oil prices rise while stock markets fall, or if interest rates rise while equities decline.

According to Antoine Porcheret, who oversees institutional derivatives structuring for Europe, the Middle East and Africa at Citigroup, activity in these strategies has surged as geopolitical tensions increased.

DUAL BINARY OPTION

One increasingly popular structure is known as a dual binary option, sometimes called a dual digital. In simple terms, it is an all-or-nothing bet: if two conditions are met (for example, oil rising and stocks falling) the trade pays out a fixed return. If not, the investor loses the premium paid to enter the trade.

While critics argue these trades resemble gambling because of the binary outcome, many professional investors use them to manage risk while aiming for specific returns.

The popularity of these strategies reflects how relationships between markets have shifted during the conflict.

European equities have been particularly sensitive to rising oil prices. The Stoxx Europe 600 index has recently shown one of its strongest negative relationships with crude prices in decades, meaning stocks tend to fall when oil rises.

Some derivatives strategists say investors are now placing bets on both sides of that relationship. Early in the conflict, many traders expected oil spikes to push stocks lower. More recently, some investors have begun wagering that oil’s rally could reverse.

Banks are also suggesting hybrid strategies to clients. Analysts at Barclays have recommended trades that profit if stock markets decline while interest rates rise, while UBS strategists have suggested combinations such as stocks falling while gold rises, a classic stagflation scenario.

The surge in hybrid trading is also visible in more conventional derivatives markets. In oil options tied to Brent crude (CO1:COM [https://seekingalpha.com/symbol/CO1:COM]), unusually tight call spreads (a strategy that benefits from rising prices) have been trading in large volumes. Analysts believe some of these trades may be linked to hedging activity related to hybrid options.

Ultimately, the direction of these bets may hinge on one question: whether the conflict in the Middle East is resolved quickly or becomes a longer-lasting crisis.

If tensions ease soon, many of the unusual market relationships could unwind quickly. But if the conflict drags on, investors may continue using increasingly complex strategies to navigate volatile markets, the Bloomberg News report suggests.

MORE ON BRENT FUTURES, CRUDE OIL FUTURES, ETC.

* FOMC Preview: A Boring Day At The Fed [https://seekingalpha.com/article/4882506-fomc-preview-a-boring-day-at-the-fed]
* Market Must Now Consider Troops On The Ground In Iran As The Base Case [https://seekingalpha.com/article/4882471-market-must-now-consider-troops-on-the-ground-in-iran-as-the-base-case]
* China Gold Market Update: Resilient Demand In A Festive Month [https://seekingalpha.com/article/4882441-china-gold-market-update-resilient-demand-in-festive-month]
* IEA details rollout of 400M-barrel oil release to ease war-driven price surge [https://seekingalpha.com/news/4564584-iea-details-rollout-of-400m-barrel-oil-release-to-ease-war-driven-price-surge]
* U.S. Energy secretary says no guarantees on oil prices with Strait of Hormuz unsafe [https://seekingalpha.com/news/4564582-u-s-energy-secretary-says-no-guarantees-on-oil-prices-with-strait-of-hormuz-unsafe]