By Vito Turitto, Manager, Quantitative Analysis, S&P Global Platts (U.K.)
Market risk and hedging strategies have, particularly over the last few years, helped many market participants mitigate crude oil market fluctuations. The implementation of efficient energy hedging strategies has often made the difference between business success and bankruptcy. An indispensable element of hedging is the estimation of volatility. This article explains how a study of volatility fluctuations can be used to build efficient hedging strategies and to understand market sentiment. The key features of this analysis focus on volatility asymmetry and volatility’s mean-reversion propensity. The article finds a negative link between implied volatility, extracted from average price options, and swap prices in both the Brent and WTI markets, implying an asymmetric volatility response to changes in the underlying price. The mean-reversion propensity of volatility is also found to be rather strong in both crude grades under examination.