The Oil Drum

120 comments on Financial Intelligence: How Arbitrage Forensics Provide Insight into Saudi Knowledge

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bunyonhead on March 29, 2007 - 9:36am

Jeff,

Agree in theory. However.....

Building new tanks may be more difficult in practice than in theory, planning permission etc. You still have to pay to access pipelines, etc. Anyone building new tanks is doing it on the Gulf Coast where the real market for crude is, not in Cushing.

Major producers sell forward swaps to banks (Goldman, Morgan Stanley, etc). The banks discount them for interest rates, credit risk, location risk (resource nationalism etc), war risk, etc, etc, etc. Ultimately they get less than spot price on this...

I am not aware of any major producer selling futures strips on NYMEX, margins are too high and liquidity is too low. The banks do all this business and there is constant flow of forward producer selling in the swaps market.

Addendum: a LOT of forward producer business has been done in "costless collars" where producers buy a put option below the market and sell a call option above the market (eg $50 and $80). They are therefore guaranteed a minimum of $50 and a maximum of $80 and take floating price vs NYMEX for anything in between. There has been so much of this business in the last few years that put options are priced relatively higher than call options, known as an inverse risk reversal skew. Crazy, but true, and a reflection of real pricing flows in the market...

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SonicTheHedgeFund on March 29, 2007 - 10:25am

For those who may not be familiar with the term "risk reversal", it commonly refers to the difference in option implied volatility between the .25 delta calls & puts.

I first encountered these in the FX markets back before the Euro came into existence. "Back in the day", large volumes of risk reversals traded on Dollar-Mark, Dollar-Paris, etc.

Correctly modeling the skew is crucial to more than just the pricing of risk reversals, but to screwball derivatives of all types (e.g., single- & double-barrier knockouts & knockins, in-the-money payoffs raised to a power and then capped, etc.).

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memmel on March 29, 2007 - 10:15pm

Trying to translate using my other post. I thin they are trading out to their strong probability positions.

Assuming I'm right and hedges are use to setup big win probability distribution and limit losses. At the end of the day I cant see how positions don't translate into probability maps of gains and losses with various crystal balls. This means even slight contango in the market snapshot is a big deal.