Investors brace for oil price 'lower for even longer' after OPEC

Mon Dec 7, 2015 | 9:22 AM EST An energy installation on a property leased to Devon Energy Production Company by the Catholic Archdiocese of Oklahoma City is seen near Guthrie, Oklahoma September 15, 2015. REUTERS/Nick Oxford Reuters/Nick Oxford Investors brace for oil price 'lower for even.. By Henning Gloystein and Gavin Maguire SINGAPORE (Reuters) - Investors are betting on the oil price staying lower for even longer after OPEC's decision to ditch a formal production ceiling, pushing U.S. crude futures for delivery nearly 10 years away below $60 a barrel. This could possibly harm the ability of U.S. shale producers, among the casualties of OPEC's strategy of pumping hard to retain market share, to lock in profitable prices for future deliveries. U.S. crude futures for front-month delivery fell below $40 per barrel on Monday after the Organization of the Petroleum Exporting Countries failed last week to agree on an output target to reduce a bulging oil glut that has cut prices by over 60 percent since 2014. In the run-up to the OPEC decision, oil derivatives showed investors had, unusually, been willing to pay more to protect against a surprise rally in the price, than a surprise fall. That bet has now been unwound, meaning they are once again expecting a higher likelihood of further declines than that of a bounce back. The most popular options contract is one that gives the holder the right to sell crude oil futures at just $35 a barrel. "Oil is going to make lower lows and lower highs for the foreseeable future and, in terms of market reaction post-OPEC, I'm not surprised, but it does leave the door open for prices to fall," Gain Capital analyst Fawad Razaqzada said. LOSS OF CONFIDENCE As recently as late November, U.S. crude for December 2022 delivery and onward was trading slightly above $60 per barrel, but following the OPEC meeting, contracts out to December 2024 are below $60, trading data shows. "It means that there is a loss of confidence in the market after OPEC, and people expect low prices to last longer", said Oystein Berentsen, managing director of crude oil at Strong Petroleum in Singapore. "Hence the back of the curve will be under pressure from producer hedging via selling the back of the curve to limit loss or lock in a small profit to reduce risk." Goldman Sachs said after the OPEC-meeting that it expected oil prices to remain "lower for longer," with a risk that oil prices could fall as low as $20 per barrel. "The rising probability that markets may need to adjust through 'operational stress', when surpluses breach capacity, leaves risks to our forecast as skewed to the downside in coming months, with cash costs near $20 per barrel," the bank said. Bearishness has been brewing in the derivatives market for some time. Options data shows holdings of December 2016 put options at $25, $30 and $35 a barrel have risen 41 percent in the last two months and open interest in those three contracts now equates to nearly 90 million barrels of oil. <0#CLZ6+> "Price levels just aren't high enough for many shale producers to hedge," said Mark Keenan of Societe Generale. "In addition, due to the short production timelines associated with many shale wells because of their steep well depletion rates, there is little need to hedge five years or more into the future." (Additional reporting by Jacob Gronholt-Pedersen in Singapore and Amanda Cooper in London; Editing by Christian Schmollinger and William Hardy)

Options, 'Convertible Security' : convertible bonds or convertible preferred stock

Option DEFINITION of 'Option' A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). Call options give the option to buy at certain price, so the buyer would want the stock to go up. Put options give the option to sell at a certain price, so the buyer would want the stock to go down. INVESTOPEDIA EXPLAINS 'Option' Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset. In terms of speculation, option buyers and writers have conflicting views regarding the outlook on the performance of an underlying security. For example, because the option writer will need to provide the underlying shares in the event that the stock's market price will exceed the strike, an option writer that sells a call option believes that the underlying stock's price will drop relative to the option's strike price during the life of the option, as that is how he or she will reap maximum profit. This is exactly the opposite outlook of the option buyer. The buyer believes that the underlying stock will rise, because if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit. ================================================= Conversion Factor A factor used to equate the price of T-bond and T-note futures contracts with the various cash T-bonds and T-notes eligible for delivery. This factor is based on the relationship of the cash-instrument coupon to the required 6 percent deliverable grade of a futures contract as well as taking into account the cash instrument's maturity or call. Convertible securities Convertible Security DEFINITION of 'Convertible Security' An investment that can be changed into another form. The most common convertible securities are convertible bonds or convertible preferred stock, which can be changed into equity or common stock. A convertible security pays a periodic fixed amount as a coupon payment (in the case of convertible bonds) or a preferred dividend (in the case of convertible preferred shares), and specifies the price at which it can be converted into common stock. INVESTOPEDIA EXPLAINS 'Convertible Security' Convertible securities usually have a lower payout than that offered by comparable securities that do not have the conversion feature. Investors are willing to accept the lower payout because of the conversion feature, which is tantamount to a call option on the common stock. The conversion price - the preset price at which the security can be converted into common stock - is usually set at a price significantly higher than the stock's current price. The performance of a convertible security is heavily influenced by the price of the underlying common stock. The degree of correlation increases as the stock price approaches or exceeds the conversion price. Conversely, if the stock price is languishing far below the conversion price - a busted convertible in market parlance - the security will likely trade as a straight bond or preferred share, since the prospects of conversion are viewed as remote. ==================================== Conversion Option DEFINITION of 'Conversion Option' A clause associated with some adjustable-rate mortgages that allows the borrower to convert the variable interest rate to a fixed rate within a certain time period, or at certain future dates. The conversion option is not free; an adjustable-rate mortgage with a conversion option will typically have a higher margin, and therefore higher fully indexed interest rate, or higher costs than an adjustable-rate mortgage without a conversion option. INVESTOPEDIA EXPLAINS 'Conversion Option' To analyze the economics of a conversion option, borrowers should total up the cost of the conversion option (an initial higher interest rate and/or higher loan costs) plus the cost of the actual conversion to a fixed rate, then compare this total to the costs of refinancing into a fixed interest rate at a future date. Remember that a fee must often be paid to convert to the fixed rate, and the fixed rate that the ARM is converted to is typically based upon the market rate at the time of conversion plus a certain percentage. If the future refinancing costs are estimated to be less than the total costs of the conversion option, then the conversion option is not economical. The borrower would be better off with a traditional ARM with the intent to refinance into a fixed interest rate at a future date.