Sing Fuel Oil Implied Volatility Softens

Gloomy economic data has combined with large inventory builds to maintain heavy downward pressure on energy markets. However, demand can be expected to appear in the Northeast US as an already cold winter turns doubly frigid. Aggressive production cuts from Opec may do no more than keep the bottom from falling out of the energy markets. The unfortunate bank-Armageddon state of affairs looks set to continue with nationalization rumours swirling around RBS and possibly a large American bank.

The softening of implied volatility and thus option premiums continues to be the catalyst for hedgers to re-enter the market. For more than two weeks, Feb ’09 Sing Fuel Oil 180 cst has been trading in a tight range between $240 and $260 with only a short break-out push towards $280 before quickly falling back below $260 again. This type of consolidation allows for less risk in consumer hedging strategies such as buying costless collar strips. The Feb-July $280 call strip can be purchased for zero cost by selling the $235 put. Similarly, for consumer hedgers looking for slightly less volatility, the Feb-July $300 call strip can be purchased for zero cost by selling the $223 put.

Singapore, 09:00

Energy Markets Pulled in Opposite Directions

Aside from February WTI, energy prices consolidated and in many cases pushed higher last week amid further evidence of follow-through on supply cuts from Opec producer nations. Consumer demand looks set to continue dropping through 2009 as the International Energy Agency fell into line with Opec and the US Department of Energy in predicting back-to-back years of falling oil demand. The combination of drastic supply cuts with continuing global economic turmoil leading to receding consumer demand will certainly inject uncertainty and thus volatility into the energy markets for some time to come.

For the moment, implied volatility has decreased due to last week’s underlying price action. Consolidation has resulted in cheaper option premiums, temporarily allowing hedgers to lock in long-term hedges at relative bargain prices. Using Asian options, the WTI Feb through December 2009 $65/85 call spread strip can be purchased for an average price of about $2,750 per 1000 barrels per month. By selling the $44 put in the same tenor, the call spread strip can be owned for Zero Cost thus providing the full $20,000 of consumer protection per month. The Feb-Dec underlying calendar swap is currently trading above $53.00, thus allowing for an average downside buffer of more than $9.00 paired with maximum upside protection of $220,000 per contract.

Singapore, 09:00