Consumer Protection from Opec-Induced Spike

Energy markets pushed to lows not seen since January 2007 last week as the dollar continued its rally amidst the global financial turmoil. Producer hedgers who took advantage of cheap downside puts when crude oil was trading in the $90 range have now begun to roll their positions down to the $30 level. WTI February American-style $30 puts are currently offered as low as $700 per 1000 barrels.

Traders may once again take more notice of Opec, as the cartel has once again called an emergency meeting, this one scheduled for November 29th in Cairo. The group is expected to announce further cuts in production, possibly as much as 1.5-2m barrels per day on top of the 1.5m barrels already announced.

Consumer hedgers looking to protect against an Opec-inspired price spike should look to the WTI December Asian-style $65/85 call spread, currently offered at about $2,250 per 1000 barrels. That's $2,250 of maximum risk with a possible payout of $17,750. The buyer of the call spread would profit on a short-term price spike- thus providing cheap protection against a near-term bounce higher.

Singapore, 16:00

Vol implosion in products

Vols in the front months for products are down significantly. RB Dec down 15 vols to 69, HO dec vol down 8 vols to 57. Crude remains fairly well bid only down 1-2 vols in the front and about .5 in the back.

Volatility is so high that these moves are not that surprising. Directional plays are best served with spreads if the strategy is to hold through expiry. Those trading opportunistically with options have to be careful of swings.

Again, the crude market was largely affected by equity markets. We know demand is softer, and supply reductions are not yet significant enough to send us higher. However, back month crude has strengthened, indicating plenty of buyers for longer dated energy futures.

New York, 345pm.

HCE - hedge update (Crude Inventory)

Given the strong sell off, volatility remains extremely firm (81.5% in Jan WTI). With this in mind, long put spread strategies or 3-way strategies using a short call are attractive for inventory hedgers.

For those with long physical inventory, consider the 45-55 put spread in Dec WTI (Asian) which is currently valued at $2.60/bbl. This offers good leverage for low up front premium.

For those that can tolerate margin swings, consider the same put spread with a short 69 call for zero cost. This three way position captures the high volatility and offers some downside protection while creating a short position $9 higher than the current market.

Near-Term Bearish Momentum

Energy traders continued last week to focus on the global economic slowdown and its effect on consumer demand. Front-month WTI crude oil had declined by almost 10% on the week by the end of trading on Friday despite warnings from the International Energy Agency that long-term global trends in energy supply and consumption were unsustainable. The current (relatively) low crude prices have resulted in alternative energy supplies such as Canada's oil sands and finds off the coast of West Africa to be given lower priorities. State-run oil giants are also being forced to shoulder larger economic burdens, resulting in less re-investing in declining fields. The WTI future's curve serves as a striking reminder of where prices are expected to trade as the economic turmoil dies down. December 2008 is currently trading around $61.00 vs December 2010 trading close to $78.00.

Despite long-term calls for crude oil to push higher, the short-term picture remains fundamentally bearish. To capitalize on the downward momentum, traders and producer hedgers have been using Asian options to buy up cheap near-dated vertical spreads such as the December $50/60 put spread, trading around only $3,400 per 1000bbls. The put spread can be purchased for Zero Cost by selling the December $70 call. This trade puts no premium at risk at or below $70 in WTI crude oil and the December Asian options do not expire until the end of the 2008 calendar year.

Singapore, 23:00

Market unable to sustain rally

Whether we call it more of a range bound market or not, we have not been able to sustain a rally. The equity markets Wednesday were bearish following the news of President-elect Obama, and some negative earnings surprises. Energies did not respond well to apparently bullish inventory data, which tends to spell a potential for downside here overnight. However, we see a trading range forming with consumer hedgers increasingly locking in 2009 value when we reach the low 60s. That said, volatility remains remarkably strong overall. The best near term strategy is to roll crude spreads forward, avoiding too much long volatility. We continue to recommend long call spreads or long call 3-way strategies for consumers. Long inventory players would be better to opt for put spreads or longer dated (at least Jan) crude puts that are not subject to too much value erosion over the next week. Note that December American crude options expire on a Monday, which is bad for option owners.

New York 17h20

Cheap Protection Highlighted Against Volatile Markets

Traders yesterday turned their focus to announcements from Saudi Arabia, the world's largest oil producer, that the country would begin cutting production and exports to customers in the US and Europe. Opec is desperate to put a floor in the volatile and declining oil price, hence the large cut, to the tune of about 5%. However, the price jump is seen by many as an opportunity to lock in higher prices as the market continues to trend towards $50. The underlying trend lower is supported by weak demand fundamentals in the current economic turmoil.

The $7 rally in WTI crude yesterday highlights the need for hedging strategies with limited loss potential- the market is too volatile to simply enter the market by selling or buying swaps. Cheap option strategies are available which provide unlimited gains with only limited loss potential. Using Average Price Options, the December $55/70 put spread is currently trading around $5.00. That's $5,000 of maximum loss potential (yesterday's rally would have resulted in more than $7,000 of losses by selling swaps) with a potential payout of $10,000. For unlimited downside protection, producer hedgers can buy the December $60 put for only about $2.80. That's $2,800 of maximum loss potential against unlimited gains should crude oil continue lower in the current economic turmoil.

Singapore, 08:00

Cheap Protection Strategies

Energy markets dropped sharply again yesterday, all but erasing last week's gains. Front-month WTI crude oil sank below the $65 level while Singapore Fuel Oil 180 also gave back gains, losing almost $25 to trade below $280. Implied volatility remains firm in the paper market as hedgers have realized the benefits of buying cheap puts to protect against long swaps and even cheaper calendar call spreads to protect short physical postions.

Naphtha and gasoil prices continue to drop as well, prompting more and more hedgers to enter the market looking for inexpensive producer strategies. NYMEX will within a few weeks list Fuel Oil options contracts on their Clearport clearing system, but until that time, cheap, short-term strategies are available using highly liquid WTI options. Using Average Price Options (Asians), the WTI December 2008 $40/55 put spread is currently trading at only $2.00. That's $2,000 of total premium at risk with $13,000 of profit potential. Fuel Oil consumer hedgers looking for an entry point to buy the 180 or 380 Swaps may want to consider buying the above put spread to protect against downside losses.

Singapore, 08:00