Oil prices, Syria and the probability of a price shock

The fundamental backdrop according to Goldman Sachs appears to be bullish in the short-term based on supply data. Unfortunately fundamentals usually explain why an underlying asset moved the way it did after the fact. Making money in the short term as a trader is difficult when basing entry and exit decisions solely on fundamentals.

With the fundamental backdrop explained, I thought it would make sense to look at key technical levels in the oil futures price chart. The chart below illustrates key price levels based on recent price action in oil.

Obviously the consolidation zone is setting up for a large move in oil prices. The more important question to answer is which direction will oil prices move? Will we see activity or supply data that pushes prices above the resistance zone? Under that scenario, the next logical price target for oil would be between $121 - $130 per barrel.

Should prices reverse course and break below support we should see strong buyers come in around the $90 - $95 per barrel price zone. At this point, the next stage in my analysis is going to be probability based support and resistance for oil futures.

This process has to do with calculations involving implied volatility to derive a probability based on price action today. Clearly those probabilities change constantly, but the probability data set is accurate in real time or at the time of entry.

Traditionally I will use standard deviations to help determine price ranges as well as setting up trades that are directional such as credit or debit spreads. Other times I will use standard deviations to place credit spreads like Iron condors which focus more on the passage of time and are generally more agnostic to price action.

One standard deviation is typically calculated as 68%. Based on the options on oil futures which expire in 36 days on October 18th, a one standard deviation move would place oil prices around $103 per barrel to the downside. A one standard deviation move to the upside based on Wednesday’s closing prices would put oil prices around $110 per barrel.

Interestingly enough, the price range expectations for a one standard deviation move from current prices today (09/11) at the close fits precisely into the price range discussed above using technical analysis.

Varying data lining up like this does not always happen this precisely, however when key price levels line up in this manner it should not be ignored. The option data is basically indicating that there is a better than 68% probability that in 36 days the price of oil will be in the $103 - $110 per barrel price range.

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