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Oil Market Prepares For Super Secret Mexico Hedge

Wall Street banks have started preparing their positions on oil ahead of the annual Mexico oil hedge, in which Mexico places bets of as much as US$1 billion to protect its coffers from oil price volatility in the next 12 months.

Reuters quotes traders and brokers as saying crude oil future and options has seen an increase in the past week, which suggests the time of the hedge is near. The deal is the most secretive in the oil world and is followed closely by banks as a sort of weathervane for oil prices. A handful of these are directly involved in the hedge: Mexico buys put options on oil from them and from oil supermajors in a series of about 50 transactions, Reuters recalls.

A few of the Reuters source said the prices for oil options for next year had jumped considerably following a report by the news agency that quoted a Mexican Finance Ministry official who said the ministry had completed the calibration of the formula it uses to place the bets.

“Within minutes of that announcement, we saw a big pop in implied volatility,” one source told Reuters, adding “It rallied in the December 2019-June 2020 range, which is typically where the hedges lie. That volatility has been well-bid the entire week.”

Implied volatility, according to Reuters, an indicator for demand for options, had increased over the past week, and so had the trade in futures, which could mean the hedge has begun. The investment banks and oil companies selling the put options to Mexico seek to insulate themselves from market volatility by upping their oil futures sales, too.

So, while option prices rose, futures prices fell last week, as traders exited their positions ahead of the hedge, the Reuters sources said.

This year’s oil sales in Mexico were hedged at US$55 per barrel, with the total value of the put options bought standing at US$1.23 billion.

By Irina Slav for Oilprice.com

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