When Laura and Marco barreled toward Louisiana and Texas this week, companies closed more than four-fifths of offshore oil production in the Gulf of Mexico to protect equipment and personnel. Crude-oil prices barely budged.
The insouciance was symptomatic of an exceptionally subdued summer in the market.
After convulsing this winter and spring, prices have crept slowly higher over the past two months. Futures for Brent crude, the benchmark in international energy markets, failed to move $1 a barrel in either direction for seven weeks in a row, the longest such streak since 2002.
Prices have been lulled by two main factors, traders say, enabling Brent to find a new equilibrium at around $45 a barrel while the main gauge for U.S. oil stabilized slightly below that level.
Production cuts by major oil exporters helped offset a stuttering recovery in oil demand. And money managers have wagered on calm oil prices using derivative contracts known as options. Those bets can act to suppress turbulence in financial markets.
After wild price swings this spring, hedge funds and other investors wagered that volatility would subside by selling options tied to West Texas Intermediate and Brent futures, according to Vito Turitto, lead quantitative analyst at S&P Global Platts.
One way to do this is by selling so-called strangles. The trade involves selling a put option: this gives its owner the right to sell WTI futures at a set price by a certain date. Meanwhile, the investor sells a call option, which gives the owner the right to buy at a different price.
Funds that sell strangles are wagering that WTI futures will trade between the strike prices for the put and call options. The funds collect a premium, compensating them for the risk that prices break out of that range and the buyer exercises their right to buy or sell.
Strategies such as this are known as selling volatility. They have become commonplace in financial markets during a decade in which ultralow interest rates have prodded investors into creative methods of juicing returns.
In recent months, those strategies have helped to squash what is known as implied volatility in oil markets. This is an annualized measure of expected price swings over the next 30 days. It is derived from option prices.
Implied volatility in WTI futures has dropped from a peak of 345% on April 21, the day after prices turned negative, to just under 30%, according to option-pricing tool QuikStrike.
“The low-vol trades for sure played a massive role, even a leading role” in driving down volatility, said Mr. Turitto. “Everyone was on the same page and they just thought the oil market had reached the bottom and the vol. couldn’t go any higher.”
Selling volatility has also helped stabilize the underlying price of WTI, some traders said.
One reason: dealers taking the other side of the short-volatility trade, such as banks, find themselves placing the opposite bet on volatility through WTI options. To hedge their exposure, the banks sell WTI futures when they rise toward the strike price of calls, and buy futures when they fall toward the strike price of puts.
“Hedging has the consequence to push prices back within that range,” said Marwan Younes, chief investment officer of Massar Capital Management.
Historically, long periods of calm in financial markets have tended to end with a burst of volatility, according to Mr. Younes.
“It feels like we have two tectonic plates building up energy,” he said. “The day it gives way will be a fairly eventful day.”
Oil rigs in Odessa, Texas.
Photo: Cengiz Yar for The Wall Street JournalIt is hard to call the direction of oil’s next big move, said Trevor Woods, chief investment officer at Northern Trace Capital. Several forces could push prices down, including the removal of sanctions on Iranian oil if Democratic presidential nominee Joe Biden wins in the November election.
“This has definitely been a remarkably stable period for prices throughout the summer,” Mr. Woods said.
Unlike U.S. stocks, which keep marching higher, oil prices lost momentum in early July after having recovered from their April nadir. WTI futures wavered Thursday around $43.39 a barrel.
Investors are wary of pushing WTI above $45 a barrel out of concern that producers would rush to lock in prices by selling futures, said Vincent Elbhar, co-founder of GZC Investment Management, a commodities hedge fund.
“Above $45, it feels like there’s going to be such a heavy amount of hedging that the market doesn’t really want to go there,” he said.
The subdued price moves over the past two months contrast with the gyrations that wracked energy markets when shelter-in-place orders hammered demand earlier in the year. WTI futures posted swings of over 3% for 19 weeks in a row from February to early July. In one week in late April, they plunged by almost a third, briefly sending the price of a thinly-traded contract below zero for the first time.
So far, Hurricane Laura hasn’t triggered a repeat of those wild swings. Laura hurtled ashore near the Texas-Louisiana border in the early hours Thursday, threatening lethal flooding and wind damage. WTI prices have largely shrugged, rising 2.5% this week.
However, some traders are bracing for a jolt.
“It will break one way or another, probably relatively soon,” said Mr. Elbhar. “When the market gets used to a very low-volatility regime, when it changes, it tends to be quite abrupt.”
Write to Joe Wallace at Joe.Wallace@wsj.com
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