Focus Turns to the Downside

The rally in oil markets has proven to be short-lived as commodities followed equities lower on the back of further talk of bankruptcy for US auto makers General Motors and Chrysler. Curiously, the crude futures curve remained intact for the most part, leaving the recent broadening of the contango structure in place. The Dow pushing back towards 7000 paired with crude inventories at levels not seen since 1993 simply proved too much for the recent rally, and attention has once again turned to the downside.

Many traders see refined products as having led the way lower and refinery margins remained basically unchanged throughout yesterday’s market rout. It has been no secret that industrial fuel demand has been much harder hit than gasoline as a result of the current economic crisis. Oil products used to fuel power generation, transportation and industry have seen a relative collapse in demand. Singapore Fuel Oil backed off recent highs, and just as with crude oil, the product is trading back below support levels. Expect further downward pressure as implied volatility has increased, thus indicating a renewed focus by traders to the downside.

Option strategies can be used to hedge against any downside risk while providing for breathing room on the upside, thus decreasing and limiting painful margin calls. For instance, the Sing Fuel Oil 180 May09 $220/250 put spread can be owned for $12/MT. The max possible loss on this hedge is the total premium paid for it ($12), and it provides protection down to $220. The put spread can be owned for Zero Cost by selling the $298 call in the same tenor. With the underlying swap trading around $261, this zero cost strategy provides $30 of downside protection with $37 of breathing room on the upside.

Singapore, 09:00