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Blue Line Futures President on oil crash: This is not over

Bill Baruch, President of Blue Line Futures, joined Yahoo Finance's Jen Rogers, Myles Udland, Melody Hahm, and Dan Roberts to discuss the state of oil after this week's historic crash.

Video Transcript

MYLES UDLAND: Of course, the big story in the market this week is what's been happening with the price of oil. For more on that, let's bring in Bill Baruch. He's the president of Blue Line Futures. So, Bill, I-- I guess I would just start with how you're thinking about a market that saw a physical commodity settle at negative $37 a barrel and-- and what that action was like from your vantage point on Monday.

BILL BARUCH: You know, it was a historic thing to watch, but-- but May contract was a physical delivery contract and really wasn't the main contract that's out there. June was the-- was an actual tradable contract. So it-- I took it with a grain of salt. I really want to focus less on-- on what happened with May other than it being a historic event to-- to witness. But ultimately, we did believe this-- this was going to get ugly. It was going to get ugly because there's absolutely no demand out there, and there's no timetable for seeing demand come back on.

But-- but this-- this is not over. That's the real-- real thing is-- is June yesterday actually made a-- a real record low, $6.50. The markets responded a little bit from there. But now we're seeing negative option strikes that are going to come and be active after the close today, and that is a complete game-changer. And it really-- really makes me worried. There is going to be some carnage out there because you-- the futures are really driven by options. If you take a look at it, institutions are not sitting there trading lots of crude oil, which is a contract size referred to as lots, so institutions are not sitting there swing trading crude oil.

They're-- they have option strategies on. And then there's other institutions that are hedging with options, and then the market makers are laying off their option risk. So ultimately what this is, is you're now going to have demand on the negative strikes. It's going to be created. It's going to drive the futures because they use futures to then hedge their option exposure. So it's going to drive futures lower potentially.

So listen, I don't know if I'm going to wake up tomorrow and crude oil is going to be at negative $5 for June or positive $25. I don't know, and I'm not trading it in that manner right now. But what I do know is it's going to be volatile. And we're already getting notices from some of the clearing firms that they're-- they're either raising margin restrictions or they are going to start blocking off the contract to be traded because there is so much uncertainty.

And then the-- managing the risk is really where the big problem comes in because every single trading platform out there, and this is not being talked about enough, but every single trading platform out there is not built to handle negative strikes in crude oil. Now, interest rates have had negatives, but this is something that-- that the model, the Black-Scholes model, cannot handle. And they got to put on a-- it's a Bachelet model, which a lot of them can't handle right now and they're developing in order to handle. So it's going to be ugly out there, a lot of volatility.

MYLES UDLAND: So a couple of questions there. You know, last night, we saw Interactive Brokers come out and say that they're plenty for a $88 million loss based on some positions that their customers had that had to be force liquidated, so, you know, those customers now owe them money. I guess the question that-- that I had, and I don't know if you know the answer to this, but is, like, who feels the pain from a settlement that is at negative 37, or even just who's feeling the pain right now with the-- the price of crude, you know, floating down from 30? And it was crazy when it went to 20, and now we're talking about the low teens as, you know, somehow at a normal level for crude. I mean, who is really, you know, bearing the brunt of this?

BILL BARUCH: I think going back to Monday, when May-- the May contract did that, there really wasn't real pain out there because of that. That was the fact that nobody wanted to take physical delivery of crude oil today. And what we are-- what we are going to see, though, and I said it in my morning note yesterday, that when the WTI for June hit $6.50 overnight before yesterday, that was a bigger deal. Or crude oil in June below $15 even was a bigger deal than negative May crude oil. So I-- I think the pain is really actually going to be start being felt now.

And you look back at-- at $17 was really a-- a massive support level. We broke below there through the early part of this week in the June contract, and now that's almost-- it's really acting as resistance. And so you have a little bit of a consolidation going on right now. And it-- it appears that we could see this thing fall out of that consolidation, and this is where the pain is going to start-- it actually has begun to be felt. And I think you're going to see that up or down the-- the energy sector. You're going to see, you know, producers are going to see-- there's potentially going to be layoffs.

There's going to be a point at-- at which you can't-- this is not being hedged anymore. They-- they can't get rid of the crude. You're-- you're basically as well, in the inventory side of it, you're maybe one inventory report away from record storage levels, but there's really no more storage out there. The difference than 2017, when that record storage levels hit, there-- there was-- the demand destruction wasn't there. It was with supply issue. It wasn't really so much of a demand issue as it is now. There's no timetable to seeing this demand come back on, and that's really where the problem is.

MYLES UDLAND: And what was that name of that-- that new options model? Not the Black-Scholes, the other one.

BILL BARUCH: Yes, Bachelet. And it's a-- it's a new model that's out there, and these platforms don't have it yet. The interest rate traders, the stir traders out there, they have had it. But a lot of these platforms don't have it ready to go. Everything from-- from Bloomberg down to what I-- I use, the CQG platform, there's other third party platforms out there that they don't have these-- this on the trading platform. So they're all rushing to out-- to roll it out. There's beta-- there's beta versions out there for some traders that-- that are going to be, you know, market making in there, but it's-- it's going to be a process. It's-- again, I use the word carnage because whether this market goes higher or lower, there's going to be carnage out there.

MYLES UDLAND: All right, Bill Baruch with Blue Line Futures. Always good to talk to you. Bill, thanks for joining. Talk soon.

BILL BARUCH: Thank you.

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