MyDVICE

- LETTER & VIEWS by NEV R. AGN

Discussing the Gold-Oil ratio (again) – structure to target a return and potential overshoot of the long-term equilibrium level of 14:1.

16 June 2021

In my posts dated 9, 10, 15 June 2020 and most recently 8 March 2021, I stated the proposition that the gold-oil ratio will revert to its long-term equilibrium level (see chart below).  I propose the following option structure to take advantage of an overshoot to 12:1 (assuming gold maxes out at $1900 over this period, this would equate to a Brent price of over $150).  However, this strategy will limit itself to an 18-month Brent target of $125.

As a side proposition, I forecast that the Brent premium over WTI will revert to a discount as per its long-term equilibrium levels (see chart below).  In which case I expect that the move in Brent will be matched at a faster pace by WTI.  Hence, I shall be proposing to use WTI for this options strategy (i.e. a WTI one-year options calendar bull spread):

1.  Sell December 2021 WTI 56 Put, Expiry 16 November 2021, premium received = 1.54.  Futures reference = 69.05. Implied Volatility = 36.69%, Delta = 12, Vega = 0.09, Theta = 0.008.  Skew to ATM = +6.84 points.

2.  Buy December 2022 WTI 90 Call, Expiry 16 November 2022, premium paid = 1.29.  Futures reference = 63.02. Implied Volatility = 26.27%, Delta = 12, Vega = 0.16, Theta = 0.004.  Skew to ATM = -1.44 points.

Structure receives premium = 0.25.  Delta neutral, net Vega = +0.07, net Theta = +0.004.

Additional Reasons on why I like this structure:

1.  It is a long vega position at a time when implied volatilities have retraced quite a bit from the highs of 2020.

2.  The longer dated option strike is still below the magic 100 level.  Assuming all goes to plan the strategy could be in the money by 20 or even 30 points way before expiry.

3.  Time decay is not an issue.  In fact, it is positive for this structure.

4.  The structure starts off delta neutral.  In other words, one can trade the gamma if the market goes our way.

METALS #7 - ENERGY #13

Further thoughts: 

(a) Excellent cointegration of Brent and WTI and the long-term equilibrium of the spread.

(b) Cointegration of the volatilities between Brent, Gold and the Gold:Brent ratio.  It is the price of Brent that moves more to correct the Gold:Brent ratio back to its long-term equilibrium level.

(c) Notice how similar the two charts below are.  Does the Gold:Brent ratio cointegrate well with the Brent-WTI spread?

5Y Weekly – Gold:Oil Ratio

35Y Monthly – Brent-WTI Spread

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