Oil prices have surged over the last week amid rising tensions in the Middle East, which have markets bracing for a potential rise to $100 a barrel.
Prices rose about 9% last week and traders in the options market for oil showed record interest in call options for $100 a barrel oil in November, while $100 call options for December were at their highest level since Sept. 20, according to FactSet data. Call options give traders the right to buy oil futures contracts at that price, though they aren’t obligated to do so.
This comes after Iran launched a massive ballistic missile attack on Israel last week, which the Israeli government has vowed retaliation for. That has raised concerns about a broader conflict in the Middle East involving Iran, which has aided its proxies Hamas and Hezbollah in their war with Israel, as well as the Houthis in Yemen, who have attacked shipping in the Red Sea and Gulf of Aden.
“We’ve seen one of the biggest jumps in oil price volatility in over two years,” said Phil Flynn, senior account executive and market analyst at the Price Futures Group and FOX Business contributor. “This is a market that seemed to be immune to geopolitical risk factors, they seemed to ignore them and you had hedge funds driving prices lower time and time again. And now this is a wake-up call because this is getting real.”
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“This has the potential to actually disrupt a major oil producer’s supply, that’s going to be harder to replace. And if we do see a cutoff of a substantial amount of Iranian oil exports for whatever reason, the world is going to be in one of the tightest supply versus demand situations we’ve been in probably in a generation,” he explained.
“It could lead to big price spikes, causing problems not only for the global economy but for the Federal Reserve in trying to balance the impact of a price spike in oil on the economy, slowing it down, versus the renewed inflation pressure that could come from an oil price spike,” he added.
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Oil prices for Brent crude have risen over 2.5% on Monday as of late morning, topping $80 a barrel for the first time since Aug. 12, which brings gains over the past five days to about 11.5%.
Flynn said the rising geopolitical tensions has traders in the energy market increasingly hedging against the prospect of oil surging to $100 a barrel.
“I think $100 a barrel in the short-term is a worst case scenario. But that doesn’t mean that there isn’t a lot of activity in those options to hedge against that worst-case scenario. In fact, if you look at the volume of options that are being priced over $100 a barrel, the volume tripled from what it normally might be for a lot of reasons,” he said.
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Flynn explained that there have been “a lot of people that have been bearish in this market that have been caught short, and are paying for protection against a worst case scenario.”
“You also have people that use the product that are saying, ‘Hey, look at the world right now, if this thing really expands in the Middle East and supplies are cut off, we could see $100 a barrel and we’ve got to hedge ourselves against those worst case scenarios,'” Flynn said.
“Even though these options are far out of the money, if you get a big spike in the price of oil, you can double or triple your investment on that type of situation. And if it doesn’t happen, well your risk is basically limited to what you paid for the option,” he said. “A few weeks ago, they were basically giving those options away, but now with the increase in volatility, they’re not nearly as cheap as they were just a couple of weeks ago.”
