Download Derivatives Project_CLH5_vFinal

Hoya Investments
Oil Investment Strategy
Karim Anchassi
Diego Bacci
Claudia Casiano
Karine Milhomens
Business Problem
• We are an Investment Management firm that focuses on the
Energy Sector
• We serve long-term investors with a moderate risk appetite.
Our executives embrace a hybrid strategy of long-term
investments while having the capacity to take advantage of
short-term opportunities
• Our analysts have analyzed the downward trend in the price
of oil over the past six months and the more recent steep fall
of crude oil prices
• Current position is short ~US$10mn in crude oil futures
maturing March 2015 (CLH5), equivalent to 147 contracts.
Further discussion will follow
• Contract: 1,000 barrels currently @ US$67,580
Overview – Crude Oil Futures
• West Texas Intermediate (WTI) and North Sea Brent crude
oil are the major benchmarks for the world’s oil
• The main futures exchanges are the New York Mercantile
Exchange (NYMEX) for WTI and Intercontinental Exchange
(ICE) for North Sea Brent; they trade “light-sweet” crude oil
• Crude oil options are the most widely traded energy
derivative in the NYMEX and ICE
• The underlying of these options is not actually crude oil
itself, but crude oil futures contracts
• Trading on these options ends three business days before
the termination of trading in the underlying futures contract
Market Overview – Oil in the News
• The Nymex WTI front-month dropped $8.70 or 9.3% over the
month of October to average $84.34/b, its lowest value in more
than two years.
• Expectations of tighter US monetary policy boosted the value of
the dollar, with potential decreasing oil demand impacts for nondollar economies since oil is priced in USD on the world market
• Oil producers and market makers hedging in both the ICE and
NYMEX crude options markets have reinforced the price drop
• The Central Bank of China’s announcement to cut interest rates
created a temporary rise in crude oil prices in the week of
November 21, 2014 by igniting hopes in oil demand
• On November 27, 2014 the OPEC decided to maintain current
output levels, confirming that oil supply will remain high and
pushing oil prices further down
View: Direction
CLH5 Price Performance To Date
Source: Bloomberg
Moving Forward - Direction
• We expect the price of oil in the near future to
continue to have a downward trend, with a limited
downside
• As the graph on previous slide shows: during the past
6 months the price of oil has had a decreasing trend
• WTI is now down 37.8% from its June 2014 peak
• As mentioned in OPEC’s July 2014 Oil Market Report,
production of non-OPEC countries in Latin America,
the U.S. and Canada will continue to drive production
of oil up without intervention from OPEC
• As inventories increased, the risk of shortages was
reduced, which began to drive prices down
Moving Forward - Direction
Historical World Oil Production vs. Consumption
100000
Thousands of Barrels Daily
90000
80000
70000
60000
50000
40000
30000
20000
10000
-
Total World Oil Production
Total World Oil Consumption
*Source: BP Statistical Review of World Energy 2014
• As seen on the graph above, historically, production levels
and consumption levels have followed a very similar trend
• We believe that this trend will hold true in the future: even
at higher supply levels, customers will eventually begin to
consume more, which will ultimately help stabilize price
View: Volatility
CHANGE TO HVG
Source: Bloomberg
Moving Forward - Volatility
*Source: BP Statistical Review of World Energy 2014
• Alternative sources of energy like natural gas
(production up 48.76% in the past 28 years) have
increased and become more available
• The increased availability of energy alternatives will
contribute to higher levels of volatility in oil prices
Moving Forward - Volatility
• Ongoing unrest in Libya, Ukraine, and the Middle
East produces fear of disruption in exports
• Given increasing volatility levels of approximately
820bp in the past 6 months, we expect volatility for
Oil prices to be high in the near future
• The market instability in OPEC countries like Iraq or
Venezuela have and will keep oil price volatility high
• LINK to Direction: Our view on direction is a
downward trend, but given the volatility, we see
potential fluctuations on both sides, although limited
Business Risk
• Position: We are short 147 crude oil futures
maturing March 2015 (CLH5)
• We do not consider that the price of oil will decrease
significantly from the current levels, given the recent
steep decline
• However, we still perceive a potential small decline
from the current March 2015 futures price. We can
generate income from putting a cap to our position
beyond certain prices
Risk Management
• Total exposure: -F US$10 million  -147F
• We want only a 5% chance of losing more than a
US$500,000 loss limit  equivalent to a 1.65
standard deviations move up
•
•
•
•
0F.25
= US$67.56 (Source: CME; Dec 3 2014)
0R.25 = 0.2346% (3-month LIBOR rate)
Volatility = 18.426% Source: CLH5 HVG Vol Chart Dec 3 Bloomberg
Risk Premium (RP) = 17.9747%
– Jul 1959 – Dec 2004 RP: 20.67%
– RPH Adjustment: 5.61%
• Based on Bloomberg CL 2004 – 2014 prices
 Critical price = US$77.4303
Risk Management Decision
Given our analysis of the loss associated to the
critical price of US$77.43, for the underlying risk,
we should hedge our position by buying ~66%
forward futures and leave a maximum of 34%
unhedged to meet out risk management guidelines
• Current position of -147F
• Hedge: US$6.6 million @
US$67.56k/contract; BUY ~98 contracts
• Given Keep Ratio of 34% (~49 contracts short)
Price Value at Risk
Current Position: Unhedged –F
•
•
•
•
Position: -147F  short 147 contracts; @67,560/contract
Name: Short Forward
View: Down, Sure
Purpose: Trading (T)
Option Prices
• The team has explored the following options as it
considers there is potential for small fluctuations
• Not hedging may result in losses if prices up or forgone
opportunity for profits if prices do not change a lot
Call
Put
Strike Price
Premium
Strike Price
Premium
More OTM
$69.50
$2.9369
$65.00
$2.7966
OTM
$68.50
$3.3879
$66.00
$3.1774
ATM
$67.50
$3.8891
$67.50
$3.8390
ITM
$66.00
$4.7411
$68.50
$4.3301
More ITM
$65.00
$5.3525
$69.50
$4.8814
Premiums reported in Future Value
Source: Daily Information Bulletin PDF CME Group 3 Dec 2014
Recommended Position: Syn Short Butterfly
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•
•
•
•
Position: -147F +294C -147Cotm -147Potm
View: vol trade, < straddle
Purpose: Trading (T), Income (Y), Insure (I)
Maximum Loss: -US$282.9K
✔ Complies with our Risk Management parameters
Upside: US$75.7K if prices down; US$2.2K if prices up
Alternative Hedging Strategies: Overview
View: vol view, small fluctuations
Syn Long
Strangle
Short
Butterfly
Syn Long Put
Syn Long
Straddle
Synthetic
Bear (Put)
Spread
View: limited downside
potential, unsure
Position 1: Synthetic Long Put
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•
•
•
Position: -130F + 130C We had to cut to -130F to comply with Risk Mgmt
View: Down, Unsure
Purpose: Trade (T), Insure (I)
Maximum Loss: -US$497.8K
✔ Complies with our Risk Management parameters
• Upside: positive if prices down
Position 2: Synthetic Long Strangle
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•
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•
Position: -87F + 87Citm + 87Cotm We had to cut to -87F to comply with Risk Mgmt
View: vol trade, < straddle
Purpose: Trade (T), Insure (I)
Maximum Loss: -US$498.5K
✔ Complies with our Risk Management parameters
Upside: positive both if price very down or up
Position 3: Synthetic Long Straddle
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•
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Position: -65F +130C
We had to cut to -65F to comply with Risk Mgmt
View: vol trade, neutral on direction
Purpose: Trade (T), Insure (I)
Maximum Loss: -US$497.8K
✔ Complies with our Risk Management parameters
Upside: positive both if price down or up
Position 4: Synthetic Bear (Put) Spread
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Position: -147F +147Cotm -147Potm
View: limited down, worry big up
Purpose: Trade (T), Income (Y), Insure (I)
Maximum Loss: -US$305.8K, with prices up
✔ Complies with our Risk Management parameters
• Maximum Upside: US$355.7K, with prices down
Maximum Loss and Upside Comparison
Position
Maximum Loss
Upside
Syn Short Butterfly*
-US$282.9K
US$75.7K if prices down
US$2.2K if prices up
Syn Long Put
-US$497.8K
Positive if prices down
Syn Long Strangle
-US$498.5K
Positive both if price very down or up
Syn Long Straddle
-US$497.8K
Positive both if price down or up
Syn Bear (Put) Spread
-US$305.8K
US$355.7K, with prices down
• All of the alternative hedging positions meet the risk
management parameter of a loss limit of -US$500K
• It coincides that the position that best fits our view
also has the smallest downside
Rationale for Recommended Strategy
• Despite the Short Butterfly does not exactly fit a view of
down unsure, it enables us to benefit from small changes
around the current levels. As stated before, we consider it is
more likely that the price will decrease slightly, but we still see
potential for fluctuations on both sides
• The Short Butterfly fits our view of a low likelihood for large
fluctuations. Since we consider that the price will not go
beyond certain levels, we can profit by putting a cap through
an out-of-the-money put and call on both sides of the position
• Given our recommended position, we consider that the
expected direction and volatility increase the likelihood that
the expected future price will be ITM significantly
• The maximum loss on this position (-US$282.9K) is within our
loss limit of -US$500K