Option Premiums Cheapen

Front month crude oil dropped below $106 in Asian markets yesterday as traders moved beyond the short-term impact of Gulf of Mexico hurricanes. Compared to dire expectations, Gustav looks to have been a nonevent, although further assessment of production facilities is required before this pronouncement can be fully digested by the market. Energy markets appear to be looking for the level that restrains demand growth but does no destroy it and traders are now focusing on a lack of demand going forward due to what looks like a global economic slowdown. On the flipside, energy investor Boone Pickens said yesterday on CNBC that he sees Opec cutting production shortly in order to defend the $100 price level.

Option premiums have decreased significantly in the past 24 hours and consumer hedges have become much more affordable as a result. Zero cost upside protection from the $115 level to the $130 line can be owned from today until the end of calendar year 2008 by selling the $101 put in the same tenour. This trade locks in oil prices at $115 should the market move above that level and provides $15,000 of protection with no premium at risk at or above a price of $101.

Gustav downplayed

Early market action in London sent crude down as low as $105.65 as traders sold on news of lower than expected damage from hurricane Gustav. However, we have yet to see enough data regarding production lost from the shutdowns in the Gulf of Mexico over the last week. Additionally, delays in the Houston ship channel cannot be overlooked. The market did rebound over $110. NG showed very little resilience, ending down close to 70 cents / MMBTU. Consumers had a window of opportunity earlier today. Although some traders are calling for $100 crude, we may not have near term bear market conditions until the weather risk has subsided. The Q4 zero cost collar in WTI (Asian style) is now 100 put vs. 125 call. For the same period, a low cost call spread such as the 115-125 is offered at $3.25