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.

More commodity weakness, USD stronger

The commodity selloff continued today although crude lows were set early in Singapore trading hours. The current feeling is we still have some more room to go on the downside. NG fought to go higher but in the end came off about $0.07. We will see what tomorrow's EIA numbers bring to petroleum markets Wed AM.

The Fed left rates unchanged as expected, citing inflation is still atop their list of concerns. Equity markets rallied, which also lifted the energy equities despite weaker petroleum prices. The USD strengthened against the Euro and other major currencies.

Vol remains firm awaiting the statistics Wednesday. For those long volatility, consider selling the options before the numbers. If numbers are bullish, we may see consolidation back to $120 and a vol sell off. Keep in mind, technicals are indicating support levels in the 113-116 area. If vol does come in, the short inventory players should consider hedging by adding some calls at the 130 or 140 level for October or Q4.

CT, New York. 4:30pm Aug 4.