Energy markets joined equity and bond markets last week in some of the most volatile trading seen in years. There is no end in sight as financial institutions across the western world refuse to lend to each other; investor panic has also intensified as investors pull money out of commodity and equity indexes. Realization has begun to dawn that the $700B US bailout will not halt the slowing of global manufacturing and production, resulting in sharp drops in commodity prices across the board. Front month WTI crude oil ended last week below $95 as bearish pressure continues to be exerted on the market.
Despite the volatile trading and increased margin requirements, very cheap protection is available for those with both upside or downside exposure in the form of verticals (call spreads and put spreads). Protection between $85 and $65 for the next 6 calendar months can be purchased for only about $3,800 of total risk per month. That's $97,200 of total downside protection for the entirety of Q4 2008 and Q1 2009. The premium paid for the put spread can easily be cut in half by selling the $100/110 call spread in the same tenor. The hedge would then provide a total of $108,600 of downside protection for only $1900 per month of premium. The hedger would also have $10,000 of upside risk per month between $100 and $110.
Singapore, 21:30
Sunday, October 5, 2008
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