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(Kiichiro Sato/AP)
(Kiichiro Sato/AP)

TheStreet

Why the move to hike margins sets crude up for a big spike Add to ...

The strategy for raising margin requirements for crude oil ought to work for a while, chasing out some retail money and steadying crude's price. But it also sets the market up for a big spike upwards after this round of margin increases are over and therefore creates a decent opportunity for targeting oil stocks in the interim.

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After having had such a significant effect in silver last week, Chicago Mercantile Exchange officials decided to avoid the pressures that are sure to come from Washington and try to apply the same margin increases to oil in the hope of moderating the retail speculation and perhaps the price.

The strategy ought to work for a while, chasing out some retail money and steadying crude's price. But it also sets the market up for a big spike upwards after this round of margin increases are over and therefore creates a decent opportunity for targeting oil stocks in the interim.

The bottom line is that crude oil is not silver, and the amount of retail money - the "doctors of Dubuque" - that is such a significant part of the silver trade is not such a significant part of oil and not as sensitive to margin requirements.

That doesn't mean that no retail customers are engaged in oil trade and that a margin increase, or a series of them, won't have an effect and stabilize prices for a while. But the biggest players in oil, the algorithmic traders, the hedge funds and proprietary bank desks have access to close to zero interest rate money and will be mostly unaffected by any margin increases that the exchange will apply. You can look for the increases in margins to decrease speculation in oil prices in only the most limited way.

But let's not get ahead of ourselves. The margin increase announced late Monday by the CME will take the cost for holding a contract of crude oil futures to $8,438 from $6,750, an increase of 25 per cent. We should not expect this to be the last increase either: Silver's margin increases came over the course of a week and dropped the leverage in the contract from about 17 to 1 to around 8 to 1.

With crude oil leverage before Monday hovering around 15 to 1, the equivalent increase to get leverage to where silver is today would put the per-contract margin at closer to $12,500. We should expect a series of margin increases on oil until we reach something closer to this number.

But how much money will these margin increases really shake out? It will only remove the most sensitive positions to increased capital requirements, taking out at least some of the day renters of commodity positions, who have certainly added quite a bit to the volatility and straight-up, fast-down moves in the price of oil. Removing this volatility, even if it does very little ultimately to the prices we see, are still a very useful result worth pursuing.

So, how to play it? We need to look for the knee-jerk move of oil prices downward to put some pressure on some of the oil stocks for which we have targeted prices. I've given those out in previous columns but will do so again: The big integrated oil stocks I like include Exxon Mobil , which I would love to add to at around $82 (U.S.) a share, and Chevron at around $101.50. Oil service will find value in a downdraft, and my favourites include Weatherford under $20 a share and Transocean at $66. Expect a moderating of oil prices along with the planned increases in margins that are sure to come from the CME in the coming weeks. Take advantage of this short respite to position yourself well in some quality oil stocks.

Dan Dicker is a senior contributor to TheStreet.com and has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser.

At the time of publication, Dicker was long Exxon-Mobil, Weatherford and Transocean.

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