Decreased Volatility results in Cheaper Consumer Hedging Strategies

Crude oil prices consolidated around the $115 level yesterday despite escalating fighting between Russia and Georgia amidst the oil-rich Caspian region. Possibly below the radar now are increased tensions between Iran and the West over the Middle-Eastern county's nuclear program. Hedge fund short crude positions appear to be both driving the market lower and preventing any sort of rebound. However, with a drop of more than 20% in one month's time, hedger's have been focusing on locking in the current price, whether it be a South American producer buying downside protection or an Asian airline recognizing the need to protect against a possible move higher in the second half of the year.

Option premiums are becoming cheaper as the market adjusts to the $110-120 price range. The October $125 calls are now trading around $3.30, providing unlimited upside protection for the next month if prices rebound. A maximum investment of only $3,300 protects against the many risks we see prevalent in the market today: political, military, weather, and supply and demand.

Commodity sell-off bifurcates

We have witnessed a broad commodity sell-off over the last month, which has potentially hit a crossroad. US dollar strength has put pressure on gold and petroleum, and metals demand in is clearly weak in general due to industrial production. However, we see petroleum with substantial upside risk. News regarding the former Soviet states self-organizing to rally behind Georgia is one piece of bullish news that helped bring the market back to $115 from a low of $112.72 today. To protect upside risk, consider the September WTI Asian 120-130 call spread for $2.50 / bbl - a $10 wide payment with good leverage. To achieve a lower cost, the 130-140 call spread costs $1.25/bbl. In the event of a market surprise on the supply side, this would provide excellent protection. Also to note: back month crude volatility has been steeply discounted. Consumer hedgers looking for longer term protection have an improved cost profile.