Energy prices fell yesterday as markets focused on the looming question of AIG as well as the fall-out from Lehman's collapse. AIG, the world's largest insurer, sponsors the DJ-AIG, a large commodity index which dropped more than 2.7% yesterday as investors moved out $10bn worth of funds this week. Adding to counterparty worries this week was the bankrupty of Lehman Brothers. The impact on the bank's $5bn commodity index busines has yet to be quantified but the past week has displayed, if nothing, the outright dangers of trading OTC as well as the pitfalls of counterparty risk. Trading and clearing on an exchange such as NYMEX enables counterparties to avoid any and all of the current counterparty solvency issues.
Option premiums have increased significantly this week as a result of the market volatility. Producer put spreads present a cheap way to gain downside protection against further violent moves. Using Average Price Options, the WTI Q4 $90/75 put spread strip can be purchased for only about $3.70 per month. That's $11,100 of total premium at risk, providing $33,900 of downside protection throughout Q4. The strategy can be made costless by selling the Q4 $101 call strip.
Singapore 180 Fuel Oil hedgers looking to protect their downside can combine the above strategy with the sale of Fuel Oil Swaps in the WTI/Fuel Oil crack, currently trading around $9.19.
Singapore, 08:35
Tuesday, September 16, 2008
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