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Option Speculations -- The New Bad Guys?

By  Apr 19, 2012

Topics: Geo-politics

The president has identified "speculation" as the cause for high oil prices. But as an economic observation (and not a political one) I challenge anyone to explain how that works.

How does speculation cause oil prices to rise? The fact is, speculation is an activity all investors engage in. You speculate that a stock's price will rise when you buy shares. You speculate in the same way when you buy or sell options on oil futures or even on an oil and gas ETF (such as USO).

So speculation by itself is a widespread and popular activity. There is an element of speculation in all trading and investing, but I cannot figure out how that actually raises the price of oil.

If you can make a case for how speculation does this, I would like to hear it. But again as an economic point and not a political one, how about the forces of supply and demand? the pricing decisions of OPEC? the political unrest in many oil-exporting countries such as Iran? Federal decisions to not expand domestic drilling? Don't these geo-political and economic forces have anything to do with prices?

Perhaps if domestic drilling could be truly expanded, prices would level out or fall. It seems the president has tried to find many causes, none of which were right. First it was the consumer, who should inflate tires and tune up their cars so they will use less gas. Then it was the evil oil companies making record profits (by the way, the federal government gets more in taxes than oil companies make, so do the math). And now it is the speculators who have drive up the price. How?

The troubling conclusion I have reached is that our leaders do not understand the markets or the economy. For example, the president has insinuated that speculation is illegal, and he wants Congress to authorize more funding to uncover and punish those speculators. But I have not heard anyone give examples of illegal activity among speculators. So is this just misguided myths about speculators and what they do, or election year politics? How does trading options have any effect on these prices? I always thought of options as plays on pricing, but never, ever as the cause.

I hate to say this, but I think the president is naive. His comments about speculation remind me of the observation made by Roger Blough, one-time CEO of U.S. Steel: "Steel prices cause inflation like wet sidewalks cause rain." (Forbes, August 1, 1967)