Bachelier – a strange new world for oil options

Model tuned to negative prices has implications for pricing, margining and delta hedging

A single, wild trading day in April upset decades of established options pricing practice in oil markets.

When the price of West Texas Intermediate (WTI) oil futures traded at CME plummeted to -$40 a barrel on April 20, the Black-Scholes options pricing model – which cannot compute negative prices – was pushed to its theoretical limits.   

CME responded on April 22 by switching to the 120-year old Bachelier options pricing model, which can accept negative prices. Ice Clear Europe followed suit