Calendar Strip Verticals Offer Cheap Protection

Expectations of continued demand destruction put an end to Monday's brief rally in crude prices. January 2009 WTI traded back down below $42 while the extreme contango seen lately along the future's curve relaxed somewhat. The one-year contango (Jan09-Jan10) has dropped to approximately -$13 while December 2012 and 2013 each fell more than $4.00 (compared to front-month crude only dropping about $1.50). This may be a reflection of physical buyers entering the market to hedge long-term storage. Also of note is a report from the World Bank predicting a prolonged global economic downturn which will depress commodity markets for the next several years.

As implied volatility persists at elevated levels, vertical spreads remain the cheapest protection available. Producers looking for protection against further downside moves can take advantage of the liquidity of WTI options (making trade entry and exit relatively easy) and look at calendar strip spreads such as the 1H09 $25/40 put spread strip, currently offered at $3,000 per 1000 barrels ($3,000 of total risk with $12,000 of downside protection per month). The put spread strip can be made costless by selling the $66 call in the same tenor.

Singapore, 08:00

Contango flattens in the back

Long term consumer hedgers have been drastically affected by the steep contango crude market. The prompt futures have been as much as $14 lower than same year December contracts. Call options appear dear looking forward at these levels. Today, however, we have seen a turn in the market with back months futures falling as much as $3 (December 13) versus Jan 2009. This may indicate that the carry market is fully valued with storage filling and long physical players starting to capture their buy and store strategy.

Consumers with long hedge strategies should have an opportunity to buy lower strike calls soon.

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