Market Consolidation Continues

Energy prices rallied ahead of Wednesday's U.S. oil inventory numbers. Gasoline stocks are expected to show a slight draw while crude supplies may register a modest build. Increasing tensions between Russia and Nato over continued military activity in Georgia, as well as resurgent fears over tropical storm Fay in the Gulf of Mexico served to pull oil off its recent lows. Consolidation between $112 and $118 continues.

As market participants become increasingly unsure as to crude oil's next move, option premiums continue to cheapen. Unlimited upside protection for the remainder of the 2008 calendar year can be had for Zero Cost by offsetting the purchase of the WTI September through December $120 calls by selling the $113 puts in the same tenour. Using Average Price Options, it is possible to gain protection above $120 for the remainder of 2008 with no premium at risk above $113.

Don't discount the risk before mid Sept.

Following Monday's easing of volatility in petroleum, the market has shown its fragility to potential weather event risk. We know that the seasonal peak is not for a few weeks so there is no discounting the potential for some activity affecting the Gulf of Mexico. Tropical storm Fay has not posed any threat as of now, but don't assume the risk is gone. If Fay fizzles, there could be something around the corner coming into September.

Given the easing volatility in the market (read less buyers than sellers of optionality), now is a good time to buy upside insurance. Asian style crude call options with a $125 strike for the September through December strip were offered today at $5/bbl. For lower premium trades, look to the $135 strike for $2.75.

NY, 530pm, Aug 19