Dow Jones Energy piece quotes HCEnergy

DJ Energy Options Volumes Fall As Traders Vanish

By Gregory Meyer

Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Activity in the market for oil and natural-gas options has died down, leaving some traders stuck with expensive positions and raising costs for companies keen to lock in prices for their commodities.

Energy producers have in recent years shown growing interest in using options to guard against price fluctuations. Energy options give holders the right, but not the obligation, to buy or sell oil or gas at a set price before a particular date.

Over the past year, however, companies including Chevron Corp. (CVX) and Marathon Oil Corp. (MRO) have pulled back on options trading. They did this to present clearer earnings reports to nervous investors, unlock cash or simply ride out a market that has oil and gas futures prices trading down some 70% from last summer's highs. The credit crisis also pushed some speculators, such as hedge funds, out of options markets.

Crude oil options volumes were down 38% in January and February from the same two months last year, data from the New York Mercantile Exchange show.
In the
same period, crude-futures trading was up 9%. Natural gas options volumes dropped 65% in the period, while gas futures volumes declined by 18%, according to Nymex, a unit of CME Group Inc. (CME).

"Banks, institutional traders, proprietary books of business, hedge funds - the bulk of that business and participation is just not there anymore,"
said Pete Anderson, chief executive of futures broker FC Stone Group Inc.
(FCSX). "There's a significant lack of liquidity, especially in the longer-tenured positions, compared to what there was a year ago."

Risk Appetite Abates

Market participants point to a variety of causes for the falloff, from options prices rising amid surging volatility in the futures markets, to banks'
newfound aversion to lending to speculators.

The slowdown is apparent in the Nymex energy options pit, home base for most exchange-traded oil and natural gas options. While most energy futures trading has migrated to computer screens, the complexity of the options market has kept activity largely on the exchange floor.

"We have some clients we just haven't heard from," said Raymond Carbone, president of Paramount Options, a Nymex floor broker. Remaining clients are "playing but they're playing with a much smaller risk appetite," he added. "We have bigger lulls in the day."

Volatility in the futures markets has meanwhile soared - oil's one-day price moves have regularly topped 5% this year, for example. That means energy futures have been more likely to hit certain options strike prices on any given day, potentially putting options "in the money," or at a point where holders can cash in. In response, options premiums have climbed, making them too expensive for some commercial hedgers, said Chris Thorpe, managing member at options dealer Hudson Capital Energy LLC in New York.

"It gets less attractive" with fewer participants in the market, Thorpe said.
Traders "can't get in and out of trades quickly. They take on more risk for less profit."

Stranded In A Thin Market


The effects of thinning options volumes have been in some cases extremely expensive, with some traders forced to unwind bets placed when markets were more liquid.

FC Stone last week said it expects to lose $54.4 million on a customer's energy trading account. CEO Anderson said the positions were "primarily"
in
natural gas options held by its customer, a market-making firm he declined to name.

Aside from options traded on exchanges, there's also a vast over-the-counter energy options market whose trading volumes are unknown. The value of options on commodities other than precious metals stood at $4.9 trillion in June, the latest month for which Bank for International Settlements data are available.

With some options-dealing Wall Street firms on shaky footing, more over-the-counter agreements have shifted onto exchanges through channels such as ClearPort, CME's system for sending over-the-counter trades to the exchange clearinghouse for settlement. Daily trades cleared on ClearPort rose 39% in February and 50% in January compared with the same months a year ago, according to CME.

"Nobody wants to do business with banks because of the credit risk on the other side," said Adam Robinson, director of commodities at hedge fund Armored Wolf. "When you ClearPort the trades, you're facing the exchange, not facing the bank."


-By Gregory Meyer, Dow Jones Newswires; 201-938-4377; greg.meyer@dowjones.com

Trades to mitigate premium in periods of high volatility

Looking back over the last 20 years, we have very few periods of implied volatility to match what we have seen in the last 6 months. The two Gulf wars are the only examples that come close, and they were very short lived versus this most recent prolong volatility in petroleum markets. See graph.

The best way to combat the cost of option volatility in terms of options premium is by trading using a spread. This can be done using a collar (long put, short call or vice versa), in affect doing a volatility "neutral" trade. This can also be achieved with a put spread or call spread, to decrease risk or take a uni-directional hedge.

With the current market conditions continuing to be difficult to trade, we suggest buying put spreads to hedge inventory that is already in tank, or buying call spreads against future purchases for consumers. For Jet and Diesel consumers, the distillate crack is very well offered now, so heating oil call spreads are very attractive. A second half 2009 asian heat $1.50-$2.00/gal call spread is now worth $13 cents.