Securing Upside Protection While All Eyes are on the Downside

Crude oil pushed below $120 early in the trading session and while the market settled below that pivitol level the lows reached during Asian hours held strong. Traders were abuzz with news of a large Latin American producer entering the market to purchase downside protection in the form of the December 2008, $100 puts. It was the smart money that locked in these puts while the market was trading on its highs above $140. To purchase these puts now is a wise decision to protect from further downside moves, however, the even wiser move is to purchase the same protection when it is ultra-cheap. During the almost 2 weeks that the market traded above $140, the December 2008 $100 puts were trading around $1.00. Yesterday's purchases by an unnamed Latin American producer pushed the bidding price well above $4.00.

The incident described above can be applied to any hedger worried prices may move back towards the $150 level. The December 2008 $150 calls, once trading at more than $11.00, are now valued at around $4.00. With maximum exposure of only $4,000, a hedger can have unlimited protection above $150 should the market move above that level before the December options expire. With an uncertain hurricane forecast, weak inventory and supply data as well as an ambigious letter from Iran on the nuclear issue, buying upside protection after hitting 2-month lows looks like where the smart money is heading now.