During my recent ZeroHedge debate with Randall Wray, I mentioned that at the start of the war with Iran, my friend and I were surprised at how modest the jump in global crude prices had been. I looked into buying call options, and saw that although the expected one-month futures price of crude was still fairly low (at the time), the implied volatility in the contracts made the call options relatively expensive. It occurred to me that some infineo readers might want to see these nuances spelled out. As I explained in the ZeroHedge debate, this scenario—where a war breaks out in the Middle East and some investors think crude prices haven’t sufficiently reacted—was something I had talked about for literally decades in my pop economics writing. So when it’s happening for real, it’s worth pointing out the real-world complications.
Some caveats before we dive in: The screenshots and tables I display in the post below, were created around March 11. At that time, the closing price for the May 2026 contract on West Texas Intermediate (WTI) crude was about $87/barrel, whereas shortly after I did this research, the price on this contract had peaked at $99. (As I write, it actually has come back down to about $89, based on optimistic comments from President Trump on a resolution being within reach.) Obviously, I am never giving financial advice in these blog posts, and I’m certainly not here—the point is to give more insight into how call options on oil futures contracts work.
The Source of the Prices
To get the actual prices on various call options, I went to this site. Here’s an example of what I saw:
This table gives information on various types of call options on a May 2026 futures contract on West Texas Intermediate crude oil. A call option gives the owner the right, but not the obligation, to buy the underlying contract at a particular “strike price.” If the strike price is lower than the current spot price, the option is “in the money” while if the strike price is higher, then the option is “out of the money.”
Since my friend and I thought it was entirely possible that oil prices would go much higher in the coming weeks, I was interested in seeing the potential returns on deeply out of the money options. So I scrolled down to see the prices on options like this:
Looking at the two tables, it’s obvious that the deeply out of the money call options have a lower price (the first few columns) than the in the money options.
But now let’s see what the various rates of return would be, based on possible future prices on the May 2026 oil contract.
Rates of Return at Expiration
In the table above, I looked at the implied rate of return on my hypothetical investment in call options, at three possible oil prices on the expiration date (April 16), namely: $98, $102, and $110 per barrel. Furthermore, for each of those possible ending prices of oil, I looked at what my results would have been, had I bought call options with strike prices of $95, $100, and $101.
Let’s walk through the first row just to explain how all the numbers fit together. First of all, each call option contract covers 1,000 barrels. For example, because the call option with a strike price of $95 had an asking price of $8.35/barrel, you have to put up an initial $8,350. Then, if the actual market price for a May 2026 oil futures contract is $98 at expiration on April 16, your “intrinsic value” is $3 per barrel—you have the right to buy at $95 when the going market price is $98. (Keep in mind, you don’t have to actually take physical possession of 1,000 barrels of oil; these things can all be settled financially.)
At this point, you might think you’ve done well; you bought call options that would “hit” if oil breaks $95, and it did! But no, you still lost $5,350, or 64.1%, of your original outlay. That’s because you put up $8,350 and only earned $3,000 from the intrinsic value at exercise. As the small print in the top of the table indicates, for this strike price you would need an actual exercise price of $103.35 just to break even. (We are ignoring the transaction fees for implementing these trades, but they are relatively negligible.)
So this was the first “a ha” moment for me. Although the level of crude prices was still lower than I intuitively expected (given the situation with the Strait of Hormuz etc.), the implied volatility on deeply out of the money call options on crude was much higher than was the case, say, two years earlier. In other words, you had to pay a much higher price upfront to get a call option that was $11ish out of the money with the Iranian war brewing, compared to a scenario with relative tranquility.
Another Nuance: Percentage Versus Dollar Return
Here’s another interesting quirk in the table above. One might have supposed that at high exercise prices, the options that were more out-of-the-money would have a higher rate of return. In other words, because you’re taking a bigger risk initially by saying, “I think oil is going to go way up in a month,” you might have supposed you’d be rewarded more handsomely if you ended up being right.
And yet, as the table indicates, for a realized exercise price of $110, the $95 strike call option gives you a profit of 79.6%, while the $100 strike only returns 36.8%. (And the $101 strike is even worse, at 26.2%.)
In fact—although it’s not shown in the table—the $95 strike option yields a rate of return equal to or higher than the $100 option for any possible price at expiration. This is because, for any price above $100, the former option has $5 more in intrinsic value per barrel, but only cost $1.04 more in premium. And for any exercise price below $100, the latter option has a -100% return (it expires worthless), while in the range of $95 to $100 the former option at least has some intrinsic value to keep the return above -100%. (For exercise prices below $95, obviously both options give a return of -100%.)
At first this might seem odd. Comparing the $95 to $100 strike prices options, if an investor gets at least the same rate of return (i.e. minus 100%) in some scenarios, and a strictly higher rate of return in all others, with the former, then why would anybody be buying the option with a strike of $100? Shouldn’t the demand for it drop to zero, which would make its price fall and become more competitive?
The quick answer is that this glib analysis only focused on the percentage rate of return, rather than the absolute dollars involved. Consider: Is it better to lose $8,350 or $7,310? If the exercise price of oil ends up being below $95, then investors who got into the former option lose the first number, while those getting into the latter lose the second number. To keep things apples to apples, you would want to adjust the numbers of contract for each strike price to maintain a constant dollar investment, or you could allow the investor in the higher strike prices to put the balance into T-bills or some other, plain vanilla asset that would help boost the overall rate of return in certain scenarios. I won’t dwell on it further in this post, but I thought this nuance was worth mentioning.
The Benefit of Volatility
Before closing, let me highlight one more subtlety. For those who—like my friend and me—thought markets were underappreciating the potential for massive price spikes, the table above showed a “worst case scenario,” where the exercise price at expiration was the highest the price had achieved in the interim. In general, a call option on a near-term futures contract on oil will have a spot market price equal to its intrinsic value (judging by the current market price) plus a premium for the remaining “optionality” before expiration, when the current price might hit even new highs and push up the intrinsic price at that future date.
The table below gives an example of how two of our options would be valued, if the current price (for the underlying contract) were to hit various levels not at expiration, but two weeks beforehand:
This final table uses Black-76 (Fisher Black’s 1976 adaptation of the famous Black-Scholes model, applying it to options on futures contracts) to calculate estimated prices of the options two weeks out, for the various indicated prices. The implied rate of return in some cases is far higher than if the particular spot price isn’t reached until expiration. For example, for the $100 strike option, at $110 the above table showed the investor would enjoy a return of 36.8%. But this last table shows that if crude hits $110 two weeks out, then those same call options would have an estimated value corresponding to a 94.8% return (if sold at that moment).
I also listed some higher prices, to show the explosive returns possible. These numbers reflect the in-built “leverage” in options: If oil stays below the strike price, the call option expires worthless and the investor who held on the entire time would lose all of his money. But if oil surges, the investor can make a far greater return than if he just bought a regular oil futures contract. Finally, to connect to our earlier discussion, note that in this last table, we see some outcomes in which even the rate of return is higher for the $100 contract than the $95 one.
Conclusion
I hope the timeliness of the scenario has made our exploration of option pricing more relevant. As this brief post has shown, call options and other derivative contracts may be simple to define, but in practice can produce counterintuitive results.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together the dependability of Whole Life insurance policies with the benefits of blockchain-based finance.
Twitter: @infineogroup, @BobMurphyEcon
Linkedin: infineo group, Robert Murphy
Youtube: infineo group
To learn more about infineo, please visit the infineo website.