Trade Idea: Long the Feb WTI/Brent Differential

Mita Chaturvedi recommends longing the Feb WTI/Brent differential as this week’s trade idea.

We believe there is good risk/reward in going long here. The level is lower than in all years but 2020, which it is closing in on. The options volatility skew for Brent Futures show that players are willing to pay more for downside protection than levels seen in the previous two weeks and far exceed the volatility seen on the upside.

WTI seeing a weekly increase in call volatility shows an increased willingness to pay a little more for upside risk – although it is met with more interest in downside risk too. According to CFTC data, there was an increase in short positions in both Brent and WTI with lacklustre global demand. The net positioning in WTI from money managers has dropped to such an extraordinarily short level that it may be primed for a squeeze.
It is also worth considering the closely correlated relationship between the Dated Brent spreads and the WTI/Brent differential due to the WTI Midland grade of crude setting the Dated curve.

This is a contrarian trade, so we would recommend entering in small quantities until you catch the upward trend and a tight stop once support is seen.