Oil options volatility jumped by the most in more than a year this week, as concerns that Iraq's insurgency could disrupt the country's oil exports spurred short-covering after a prolonged period of waning demand.
The CBOE crude oil volatility index, which tracks the United States Oil Fund, rose more than 30 percent. It was the largest jump since April 15 last year, when weak data from China led to a large-scale sell-off of crude.
The jump coincided with a near $3 spike in oil prices as violence grew in Iraq. On Friday, Iraq's most senior Shi'ite cleric urged his followers to take up arms against the advancing Sunni militants, an al Qaeda splinter group marching south towards the Shi'ite-led government in Baghdad, raising the spectre of further violence.
"I had been seeing a little bit more vol taking shape past couple of weeks, yesterday's jump in vol didn't come out of nowhere," said an options trader in Princeton, New Jersey. "What we saw yesterday in the last hour of trading and post close was shorts lifting any available offers in order to cover."
Iraq presents the first threat to global oil supplies since rebels closed Libyan ports, a disruption that was largely priced into the market, said Stephen Schork, principal and editor at the Schork Report.
"We had a sense of complacency because of the production boom in the United States and Canada and that contributed to a lack of volatility," he said.
"Iraq could be a different story," said a New York-based futures and options broker. "Whether on its own or now in combination with those other threats, Iraq output at roughly 3.5 million bpd has been on the rise along with U.S. output providing a cushion for OPEC."
OPEC's spare capacity could be strained by an outage in Iraq, combined with other production losses.
"Options are insurance so a pickup in interest in buying insurance is to be expected, with calls being priced more expensively," Schork said.
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