Speculators are piling into complex crude options this week, in a bet the market is going to tumble later this year on an expected slowdown in refinery demand and robust oil inventory levels.

Some 8,200 lots of bearish calendar-spread options were executed on Tuesday over the remainder of the third quarter, the fourth quarter and into the first quarter of 2016 in the over the counter market, according to CME Group's daily bulletin on Wednesday. The contracts can go days without a single trade, so the rush was unusual.

Those trades included puts, put spreads and fences, dealers say, with strike prices at negative 50 and negative 75 cents. Five hundred puts also traded at a negative $3.00 strike price for the August/September and September/October contracts.

Since the end of April, the front to second month spread has strengthened by nearly 80 percent. On Wednesday, the spread between the two underlying futures contracts settled at negative 41 cents.

The move highlights tension between New York and Houston where funds and speculators have traded the price of U.S. NYMEX crude oil up and sideways for months while physical traders in the oil capital say there is too much crude globally, exacerbated by U.S. refinery shutdowns for maintenance and growing exports from the Middle East.

"The physical market isn't trading in tune with the futures market. One of those will have to correct - either futures have to come down or physical gets better," said Tariq Zahir of Tyche Capital Advisors, adding that an Iranian deal on nuclear talks could swell the existing glut.

"People are now starting to price in that for the fourth quarter, so that would make calendar spreads weaker."

A calendar-spread option (CSO) is a financial contract based on the price of two calendar months in the futures market. The contracts are riskier because the market is less liquid than for a basic vanilla option. Traders and analysts say unexpected price swings have put counterparties on the hook for millions of dollars if the market moves against expectations.

The large number of deep out-of-the-month contracts traded reflects the first signs that a second leg of the price tumble that slashed global benchmarks by nearly 60 percent last year may be imminent.

Traders add that the buying of puts in the options market through the first quarter of 2016 has been robust and increasing.

DIFFERENT VIEWPOINTS

Divergence between the physical and futures markets is not necessarily surprising: futures traders focus on macroeconomic and geopolitical risks, while cash traders focus on pipeline outages and supply-demand balances.

But the two markets have traded very closely over the last year, as rising stockpiles at the U.S. hub of Cushing, Oklahoma, caused major sell offs in the U.S. crude futures market.

For cash traders in Houston and Calgary, the overhang of crude in the North Sea, expected imports in the fourth quarter and refinery turnaround season in the fall point to an expected and long-anticipated slump.

Those pressures pushed cash benchmark Light Louisiana Sweet to a five-month low last week near $2.00 a barrel over U.S. crude. A month prior, it traded at more than double that.

Meanwhile, financial markets have seemed more resilient, at least for now.

"We are not seeing longs liquidating yet. However we are seeing protective hedging by funds that are long, which is a sign that they are concerned about the recent price action," said Matthew Perry, a partner at energy-focused hedge fund Kronenberg Capital Advisors. "We are short at our fund and believe crude will go lower from here."

Source: www.reuters.com

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