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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Thursday, September 03, 2020

Crude WTI Market Neutral Structures

by Century Financial in Investment Insights

Crude WTI Market Neutral Structures
Crude WTI

*This performance is only observed with historical backtests and not traded by the company.

Risks & Assumptions
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The structures being a derivative product are based on option strategies whose payoff values are based on the option strikes and their corresponding market values. Kindly consult Century Staff for further details & clarifications on the same.
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Calculation for P & L are based on market prices quoted on Bloomberg at the time of structure creation. Going ahead, the option prices may change based on the underlying price movement.
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Each structure has 4 legs which involve simultaneous buying & selling of options at predetermined strikes in order to achieve a market neutral view.

Having risen by over 100 % from its YTD lows, Crude West Texas Intermediate(WTI) is currently showing signs of consolidation. The benchmark has been trapped in the range of $40 - $44 over last 2 month period. As it trades near its 5 month highs, recent correction seen is indicative of range exhaustion with prices likely to swing towards either side of the markets.

The 2 market structures designed on WTI November contract are with market neutral bias so as to avoid getting wrongly caught on either of the sides. It makes use of 4 option legs in order to target suitable price ranges as per volatility expectations. WTI Iron Condor Structure targets a range bound movement for the benchmark over the next 45 day period with annualized coupon earned around 13%. WTI Reverse Iron Condor Structure is beneficial to target high volatility in the prices over the said duration. Risk Reward ratio for this structure is 0.27.

Structure Details
Sr No. 1 2
Underlying WTI November WTI November
CMP considered $42.30 $42.30
Days to Expiry 45 45
Structure Iron Condor Reverse Iron Condor
Expected Volatility Low to Neutral High
Direction Neutral Neutral
Net Premium Received/Paid $0.64 ($0.64)
Premium as % of CMP 1.51% -1.51%
Max Profit $640 $2,360
Max Loss ($2,360) ($640)
Risk Reward 3.6875 0.2711
Suitability Suitable for clients who are targeting a rangebound movement over the next 45 days. On price basis, coupon received over this period amounts to 1.51%. On an annualized basis, this would amount to roughly 13%. Suitable for clients targeting high volatility. With net premium payout of around 1.51%, this structure has risk reward ratio of 0.2711.
Break Even Points 38.86 & 46.14 38.86 & 46.14
Max Profitability Between BE Points(Between Wings) Away from BE Points(Away from Wings)
Structure Payoffs
WTI Reverse Iron Condor
WTI Iron Condor

Risks & Assumptions

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The strategy might suffer from look-ahead bias which occurs due to use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and loses could significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy.

Data Source: Bloomberg

Arun Leslie John
Chief Market Analyst

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