Pascal's Wager... on Oil Prices?

In the early 17th century Blaise Pascal designed the argument that it is always better to believe in God than to not seeing as the benefit of believing was greater than the benefit of not. I'm not here to start religious warfare, but instead to take this idea and apply it to current oil prices.

First, let me outline my assumptions. The most important being that markets are forward looking. While numbers such as the increase in supplies do influence markets, prices generally reflect what traders believe will happen in the future.

Now let's look at the future, specifically in regards to Iran and the increased supply. It is my belief that this increase in supply (initially 500K barrels/day evolving into 1M barrels/ Day) is mostly baked into current prices with perhaps a floor around $25/barrel ($25 since people psychologically tend to gravitate toward round numbers). Again this is based on the premise that prices are forward looking.

Now for our wager scenario. Ultimately there are two outcomes, Iran does in fact output at the numbers it guided, or it does not. If we believe output reaches the guided levels, prices are already adjusted for such events and volatility would remain at current levels. On the other side however if Iran misses or delays its production targets, there stands to be significant volatility with a bias to the upside.

Our wager choices now, simply Long or Short Oil (ignoring the fact that you could just stand on the sidelines).

Shorting oil could see a modest modest gain if the commodity were to move lower, but since prices have already adjusted for Iran production, gains would be contained. Being short oil with an unexpected lower production scenario could yield disastrous results as traders would then need to reprice the commodity amidst new, uncertain developments.

On the flip side, the trader long oil stands to lose a small amount assuming an oil floor price of $25 versus the event in which Iran misses production targets and oil could move higher. Not to mention that a miss in Iranian production would move prices higher which could generate the start of a short squeeze in the commodity. This would then have compounding effects on price movement.

Ultimately, it's up for the individual to decide, but I believe there is only one trade that makes sense.

Of course, I'm not perfect so personally I wouldn't go long Oil as is, but instead would likely use options, preferring to sell put options (bullish strategy) that are lower than current prices.

Submitted January 18, 2016 at 08:48AM by jpoms13 http://ift.tt/1P02PLT