WTI crude oil bounced back up towards the $90 level yesterday on thin trading as the dollar pared gains and equities softened further. The continued shutdown of almost half the production of crude and natural gas in the Gulf of Mexico may be back in the focus of trader's attention. Interestingly enough, preceeding Hurricanes Gustav and Ike the Gulf region was able to produce 1.3m barrels per day; prior to Hurricane Katrina in 2005 the production level was 1.6m. This begs the question of can the region even return to the depleted levels of the post-2005 hurricane season? On a similar note, Pemex (Mexico's state-run oil producer) announced evacuations from several offshore Gulf platforms as tropical storm Marco bears down. This latest bullish data needs to be absorbed along with continued demand destruction figures. US oil consumption remains close to 10-year lows and products demand continues to decline at a rate of approximately 6% per month based on the previous year.
Despite a softening in implied volatility yesterday, option premiums remain inflated. The best (and cheapest) protection in current market conditions continues to be found in verticals and combination strategies. After yesterday's bounce, producer hedges should be considered this morning. Using Average Price Options, the Q408 through Q109 $85/75 put spread provides $10 of downside protection per month for only about $3.50 of total premium at risk. The put spread can be made cheaper by selling the $110/125 call spread in the same tenor at $1.00. Using this combination strategy, the hedger has $45,000 of total downside protection for the next 6 months while paying only $15,000 in total premium. The hedger also has upside risk from $110-125.
Singapore 08:50
Tuesday, October 7, 2008
Crude volatility remains high, heat/diesel hedgers active
Monday's late day floor trading action bid up crude volatility over 70%. This level subsided today to the mid 60s% for November American options which expire next week. The markets remain torn between fundamental directional hedges and the pure play asset sell-off experienced across global markets. Though led by the financial sector, the lack of liquidity in equity and bond markets have created a down draft seeking the next bid. We have not seen a sell-off in crude as one might expect. Major players may be sitting on the sidelines if not forced to liquidate. Although demand destruction in refined products (especially gasoline) is now well documented, the low inventory positions and refinery turnaround schedule should compensate. Negative RB cracks form November and December have reached $-2.15 per bbl. Heating oil remains firm with winter cracks above $21/bbl. Consumer hedgers have been active buying the heating oil upside calls.
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