Oil prices, Syria and the probability of a price shock

The oil futures price chart shown below illustrates a two standard deviation move. The lines drawn on the chart below demonstrate the next key price levels should a 2 standard deviation move occur from the current price at the October option expiration.

It is important to understand that there is roughly a 10% probability that oil will even touch either key price level shown above before the October 18th expiration. So what do all of these probability calculations tell us?

Right now the implied volatility in the options that expire on October 18, 2013 based on current oil futures spot prices has a low probability of seeing a surge higher or a major move lower. The option data essentially concurs with Goldman Sachs fundamental view that oil prices are likely to stay in a trading range and probabilities do not favor a big unexpected move.

I would point out however, that the probabilities for a big move are not 0%. There is a 1 in 10 chance that we see a big surge or breakdown in price. As far as I am concerned, this is the option markets calculated odds on any major escalation taking place in Syria or the Middle East prior to October 18, 2013.

I think in the short-term we could see oil futures prices move up toward $115 / barrel. However, the probabilities simply do not favor a prolonged move above that level. Furthermore, it seems likely that when the Syrian debacle concludes that prices will be more likely to be in the $103 - $110 price range in roughly one month.

Instead of reading articles written by pundits who are making price projections based on an educated guess, why not let the options market be a guide for where the marketplace is pricing in the next move. The analysts that are calling for a monster move in oil in the near term have roughly a 10% probability of being right. I will let readers decide whether a pundit or the option pricing in oil futures is likely to be more accurate.

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About the Author
J.W. Jones

J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. He is  primary analyst and moderator of OptionsTradingSignals.com and expert market analyst and chief options analyst for TradersVideoPlaybook.com.

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