Virtual Barrels: Quantitative Trading in the Oil Market

by Ilia Bouchouev

The global oil market is no longer solely influenced by the supply and demand of physical oil barrels. In today's landscape, financial barrels traded by hedge funds using quantitative algorithms and dealers managing large portfolios of oil derivatives are equally crucial in determining the price of oil. This book offers a fascinating insight into the world of oil derivatives, exploring the quantitative models and trading strategies used by professional market participants. With a focus on oil options and volatility trading, the reader is taken on a journey through the story of this market, narrated by one of its pioneers who managed a highly successful trading business for almost a quarter of a century. Bridging the fields of energy economics and mathematical finance, this book demonstrates how the science of trading can unearth unique opportunities in the oil market. Written for aspiring quantitative traders and academic researchers alike, it offers a rare glimpse into the opaque and secretive world of oil derivatives, showcasing how it operates in practice.

359 pages, Hardcover

Published December 2, 2023

Reviews

[Hari Krishnan · Rating 5 out of 5]

Written by an expert in the oil trading business, Virtual Barrels succeeds on many fronts. It delves deeply into the plumbing of the oil markets, specifying the major players, how they hedge exposure and their interaction with dealers and speculators. The material is generally practical and avoids excessive mathematical detail, which makes the book particularly useful for macro and systematic investors.

The book starts with the crucial observation that virtual barrels are traded far more actively, in the futures markets, than physical barrels. This has several implications. In many cases, cash prices are determined by price discovery in the futures market, rather than the other way around. More generally, there is a feedback loop between the cash and derivatives markets that can lead to exaggerated price moves and intermittent breakdowns in the futures, cash spread. The complex systems approach allows us to understand extreme events such as negative short term prices without resorting to fundamental narratives.

Virtual Barrels also provides insights into dealer positioning, based on hedging by storage operators and large scale initiatives, such as the Mexican government's use of average price options. In certain cases, we can infer where dealers will amplify or compress price moves in a certain direction. On the heels of the GameStop melt up, this gives the book a timely quality.

Highly recommended.

[Edo Campione · Rating 5 out of 5]

Ilia Bouchouev’s Virtual Barrels is a masterful exploration of how the physical and financial worlds of oil intertwine, blending economic theory, market structure, and trader psychology into a cohesive narrative. Structured into four interconnected parts, the book guides readers from conceptual foundations to sophisticated trading applications. What makes it exceptional is Bouchouev’s ability to link elegant economic ideas to real trading practice; for instance, he revives Keynes’s concept of the “commodity own rate of interest” and connects it to modern notions of convenience and roll yield, showing how holding oil physically or virtually affects market pricing. Perhaps the most intriguing section is Chapter 13, where he introduces the idea of virtual storage, demonstrating how a calendar spread option (CSO) can replicate the economics of owning physical oil and expose pricing dislocations between the paper and physical markets. Worth reading for anyone interested in modern energy trading.

[Jamie · Rating 4 out of 5]

Lots of great information but probably not the best first book on this topic as the author assumes a certain level of prior knowledge about financial products

[Evan · Rating 4 out of 5]

Very interesting to gain a broad overview of paper trading in oil markets from an experienced industry professional. Some of the topics about which I learned the most include the following:
- History of the oil market
- Theory of storage
- Historical structural risk premia in forward/options markets
- Types of trading strategies involving oil (e.g., macro trading, "quantamental", relative vega, long gamma, etc.)
- Volatility calibration