Oil’s Panic Rally Shows Signs Of Exhaustion
Exhaustion?
Oil is printing the biggest down candle since the panic began. One candle doesn’t make a bear case, but we have come a long way and a pullback would not be surprising. The 8-day moving average comes in around $91, while the 21-day sits much lower, currently near $76.
Source: LSEG Workspace
Mean reversion mania
Despite all the headlines and narratives, oil tends to be a mean-reverting asset over the longer term. Chasing breakout or breakdown momentum trades often ends badly. The recent panic move essentially tagged the 2022 highs. You could argue prices are now back near the middle of the range, but excluding the 2022 spike, oil has traded in a tighter band and remains in the upper part of that range.
Source: LSEG Workspace
Crowded longs
Bullish bets are at the highest levels since 2020.
Source: Bloomberg
The overshoot
Oil volatility makes the VIX look tiny. Expressing geopolitical fears through oil or oil volatility at these levels is, in our view, no longer an optimal trade.
Source: LSEG Workspace
Broken market
Oil volatility, with OVX around 120, signals a broken market and is unlikely to be sustainable. At these levels the market is pricing roughly 7.5% daily moves. Theta is extremely expensive, meaning oil bulls expressing their view through upside calls may quickly discover how painful that decay becomes on even a pause in oil, not to mention a pullback. Unwinding those expensive calls could also pressure spot.
Chart 2 compares OVX with silver volatility. Silver saw a similar panic spike earlier this year, with volatility exploding higher. The hangover phase has been painful, and oil risks following a similar pattern.
Source: LSEG Workspace
Source: LSEG Workspace
But there is always the panic scenario
164! Hormuz horror
"Strait of Hormuz being closed for 3 months would get Brent crude oil up to $164/barrel."
Source: Bloomberg Economics
Second panic?
Markets may have already experienced the first panic distribution. A second peak is always possible, but chasing volatility after such an extreme move rarely ends well.
