Settle For Oil

Oil Rigs

Above: long-exposure nighttime shot of oil rigs off the coast of California.

Strange things happen to options and futures on fairly predictable dates. Options expiration dates, contract settlement dates…these are trading days where – and this is just my theory – some traders just want to get out of a trade by any means necessary. So it can, in theory, lead to behaviors that can’t easily be arbitraged away. Best theory I’ve had today.

I started poking around oil, because oil futures (and their related ETFs) have so far not yielded much to my research. I thought hmm, wonder what happens around oil contract settlement day?

According to the CME Group’s helpful page on the subject:

Trading in the current delivery month shall cease on the third business day prior to the twenty-fifth calendar day of the month preceding the delivery month. If the twenty-fifth calendar day of the month is a non-business day, trading shall cease on the third business day prior to the last business day preceding the twenty-fifth calendar day. In the event that the official Exchange holiday schedule changes subsequent to the listing of a Crude Oil futures, the originally listed expiration date shall remain in effect. In the event that the originally listed expiration day is declared a holiday, expiration will move to the business day immediately prior.

Got all that? Basically, find the 25th on the calendar. If it’s a business day, hop back three business days and there’s your settlement day. If the 25th is NOT a business day, hop back to the nearest business day. Then hop back three more business days. The rest of the stuff I can’t be bothered with.

First I programmed this code into AmiBroker, so that I could export an event list of these dates as a csv file. Then I used a super-secret backtesting platform to do the actual crunching, which  I happen to be alpha-testing. I divided the data into roughly half, and tested on the first half. The out-of-sample testing was also profitable. Here’s what I came up with:

  • Buy USO (an oil ETF) at the close of settlement day.
  • Sell at the first profitable close, or at the close five days later.

Stupidly simple, right? Remember, this isn’t a real trading strategy. It’s more of an idea that you can play with. The results are ok but they’re not something I’d trade. Here’s what the equity graph looks like if you invested $100k and didn’t pay commissions.

The system is in a pretty big drawdown right now, so I wouldn’t leap up and call your broker. (Does anyone call their broker anymore? Do they still have phones at brokerages?) But look what would have happened if you’d use the same system but entered on any day EXCEPT the settlement dates:

I think I like the first graph better.

2 thoughts on “Settle For Oil”

  1. looks like the system didnt make any money since beginning of 2014 when oil started to collapse, made some in nov16-mar17 when it rallied on OPEC cut.

    1. Sure, I agree! The point of the post was not to describe a usable trading system, but to show that there might be an edge there that could be used as an idea for readers. Comparing the settlement-date trade to trading the opposite (that second graph), there’s an obvious difference. Perhaps it can be useful to someone.

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