Abstract
This study is directed at predicting the determinants of oil futures prices. We evaluate commodity pricing with oil occupying a special position due to highly inelastic demand. Given the sudden fall in oil prices, there is theoretical and practical interest in identifying the determinants of falling oil prices. While the popular press dwells on oversupply in production as the principal determinant of price declines, we examine additional predictors including call option sales and put option purchases along with the Canadian dollar-US dollar exchange rate and news of future oil prices. Intraday call and put options on NYMEX oil futures were examined. Call and put option prices of 1 - 7 month-maturities, along with exchange rates, the supply of oil and news of oil prices were regressed on oil futures prices. A trading strategy was tested based on the thesis that in a period of price declines, options traders seek to profit by selling call options and purchasing put options. While oversupply of oil was the most important determinant of oil prices, trader speculation through put buying and call selling exacerbated the decline in oil prices. Call and put option prices explained oil futures prices for options of 1 - 4 month maturities. The supply of oil was significant in predicting oil futures prices in all future time periods. This was followed by the Canadian dollar-US dollar exchange rate which was significant in predicting oil prices 1, 2, 3 and 6 months into the future. Finally, news of forthcoming events affecting oil prices predicted oil futures prices 3, 4, 5, 6 and 7 months in advance.
Highlights
From 1980-2008, the price of oil moved steadily upwards in response to demand shocks
Changes in call prices and changes in put prices were included to capture any variance of oil futures prices that was not contained in option prices
For options with 1 - 4 month maturities, i.e. the aforementioned subsamples, call prices were regressed on oil futures prices, put option prices, the Canadian dollar to US dollar exchange rate, supply of oil and news of oil prices
Summary
From 1980-2008, the price of oil moved steadily upwards in response to demand shocks. If p is the put price, F = oil futures price, x = strike price of F, or higher purchase price for oil, the Gain to the put buyer upon exercising the option = x − F − p in an era of continually decreasing oil prices This pessimism is a form of informativeness of oil prices contained in options. Traders continued to buy put options which increased in value in each time period as sellers in the oil futures market continued to adjust prices downwards. Another options trading strategy to capitalize on falling oil futures prices occurs with call selling. Buyers in the oil futures market reduce the price at which they purchase oil futures (oil future bid price) arguing that call sellers benefit from falling oil prices by never having to deliver oil futures and receiving the permanent benefit of earning call premiums
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