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A few years ago, in one of my books ("The Vega Factor"), I coined a phrase to explain the new way in which oil pricing was unfolding, along with the uncertainty resulting from it.
Then, the market was facing rising crude topping $100 a barrel.
Now, the situation finds oil rising into the mid-$60s after a bout of abnormally low prices.
The phenomenon described, however, applies to oil moving in either direction.
I called it "Oil Vega."
Simply put, it refers to the increasing inability to determine the true value of crude oil based on its market price.
Now, there is a reason why I'm revisiting this phrase now.
You see, I am close to putting the finishing touch on a new investment tool that identifies stocks based on this phenomenon.
And today, I want to give you a sneak peek at one of its main components…
Decoding the "Oil Vega"
Before we begin, I want to explain a little more about the origins of the term "Oil Vega."
I originally borrowed the concept of vega from options traders. As traders use it, "vega" relates to the way in which the price of an option reacts to a change in volatility.
They need to determine a value for the option and be able to revise their estimates on that value as market changes take place in the futures contract on which it is based.
For that, they need a pricing model.
The volatility component in their pricing model, from which one determines a theoretical value for the option against which a trader calculates the option's market price, is called implied volatility.
Simply put, vega represents the rate of change in the theoretical value of an option as it relates to a change in implied volatility.
But there is one other important matter to consider here.
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Vega is a "second order," or derivative concept to the actual change in the value of a security. It measures the amount by which the price of an option reacts when volatility changes. Volatility is simply the measurement of how often and by what amount a market factor changes.
My book then explored how the rising inability to determine actual value was playing out in a market where oil prices were progressively being driven by what traders could gain in futures contracts, rather than actual consignments of the underlying oil.
Now, I recently discussed some of the ramifications in equating "paper barrels" (futures contracts) with "wet barrels" (oil in trade) and the rising problem of derivatives as a consequence.
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.