Options for Downside Protection

U.S. oil inventory data showed a rise in crude stocks last week, reinforcing the current bearish trend. WTI front month crude came close to touching the $117 level before bouncing back above $118.50. The slow entry into the market by downside hedgers has been somewhat offset by Tuesday's purchase of December 2008 $100 puts by a Latin American producer. Sellers of the downside protection must sell futures to protect against their short put position, thus adding to the current bearish sentiment.

A popular trade continues to be buying the December 2008 $100 put for around $4.00. This trade provides unlimited downside protection below $100 until November 17th, when the option expires. Longer-term downside protection can be owned by purchasing the December 2008 through March 2009 $100 / 80 put spread strip, also for $4.00. For the same price per month for just the December 2008 $100 put, a hedger can buy every $100 put from December 2008 through March 2009 by selling every $80 put for the same months. This trade provides $16,000 of downside protection per month with max loss of only $4,000. For the hedger that expects a further downside push sometime in the next 6 months, this trade should fit perfectly.