Volatility Returns over Opec Questions

Volatility in oil markets returned yesterday after a short hiatus as crude prices drifted higher in early Asian trading, only to retreat sharply during NY hours. Traders had been banking on $70 (WTI) providing short-term support and as a result implied volatility began to retreat. However, doubts over Opec's ability to coordinate and follow through on what will surely be an announcement of cuts later this week, has caused traders to sell the market off and test the $70 level yet again. Opec's recently announced production cuts have yet to be greatly felt by the physical market and many analysts are concerned over the cartel's lackluster record in following through on its often bold announcements. Non-Opec producers Norway and Russia have declined to consider production cuts.

Hedgers can certainly expect the resurgent market volatility to affect their long-term outlook. Consumers looking to lock in prices at relative bargain levels need to be aware of downside risks should the physical market continue to push lower. Buying Singapore 180cst Fuel Oil Swaps around the $370 level should be paired with the purchase of highly liquid WTI puts. Using Average Price Options, the November 2008 $65 puts can be owned for only about $2.00 per contract. That's $2,000 of maximum exposure per 1000 bbls. If the Fuel Oil swap trends lower in the short-term, the consumer hedger can sell out the losing position which may be to a large extent compensated for by the profits on the long WTI puts. Hudson Capital Energy makes markets and acts as counterparty for both the Fuel Oil Swap and WTI puts without charging any fees. This is an optimal strategy to consider in these extremely volatile markets.

Singapore, 09:45

Basis Risk Strategies for Volatile & Illiquid Markets

Energy and metal prices failed to rebound in Friday trading as the current market volatility shows no signs of abating. Equities also failed to recover lost ground with the Dow sinking back below the 9000 level. Traders are watching Opec nervously as the oil group has called an emergency meeting for November ahead of its regularly scheduled December gathering. Late last week the cartel moved up the hastily assembled meeting to next Friday. As recently as early October with WTI crude oil trading closer to $90, some of the more hawkish members of the group issued statements claiming the world was oversupplied by between 0.4 - 0.5m barrels per day. As the market momentatily broke below $70, those extra barrels of supply were revised upwards by the group to 1m.

As traders view an Opec production cut as a fairly solid bet, it is pertinent for consumer hedgers to enter the market to take advantage of the more than 50% drop in many energy markets since only mid-July. Singapore bunker traders can protect against an Opec-inspired jump in prices while also limiting downside exposure by purchasing the Singapore 180CST Fuel Oil Swap in December at about $360. In order to avoid unlimited downside losses, the prudent hedger would purchase WTI puts (WTI options are the most liquid energy options in the commodity trading world, and help avoid the twin traps of counterparty credit risk and limited counterparties that Fuel Oil options currently entertain. These twin risks result in large bid/offer spreads making it extremely difficult to profitably exit bilateral Fuel Oil option deals). Using Average Price Options, the WTI December $65 puts are currently trading around $3.75 per contract. That's maximum risk of only $3,750 per 1000bbls of crude oil which provides unlimited downside protection should both Fuel Oil and Crude Oil continue lower. The above combination strategy represents unlimited upside protection gained from Fuel Oil swaps, with cheap unlimited downside protection from Crude Oil puts.

Singapore, 18:30

Sharp Drop Draws Out Bargain Hunters

Recessionary fears pushed crude oil below $70 in NY trading yesterday as market volatility again pushed to new heights. Energies rebounded in early Asian trading as consumer hedgers and investors looked to gain from the drop of more than 50% in crude prices since only mid-July. Not just commodities, but shipping costs as well have experienced large and rapid price falls, with the Baltic Dry Index trading at its lowest level since November 2002.

The early morning rally in crude prices has opened up fresh producer hedging opportunities. Using Average Price Options, the WTI December 2008 $55/70 put spread is currently trading at only about $4.50. That's $4,500 of total premium at risk with 43 days to profit from further downside moves in crude oil. The hedge can be owned for Zero Premium by selling the $82.50 call in December. This trade provides a full $15,000 of downside profit potential with zero premium at risk at or below the $82.50 level.

Singapore Fuel Oil hedgers looking to protect their downside can combine the above strategy with the sale of the 180 Fuel Oil Swaps in the WTI/Fuel Oil crack, currently trading around $19.50.

Singapore, 10:30

Drop in Energy Prices Results in Consumer Buying Opportunities

Equity and commodity markets fell sharply yesterday, quickly erasing Monday's gains, as traders focus on the near-term economic fallout of the current banking crisis. Opec, meanwhile, spoke out yet again on the impact on demand from the economic turmoil. It is a near certainty at this point that the cartel will cut production at its emergency meeting on November 18th. This usually bullish announcement had no impact on the market, as front-month November WTI crude has pushed below $73.50 in early Asian trading.

Despite the increase in implied volatility, consumer protection strategies have become increasingly cheaper as the market moves lower. It is now possible to lock-in crude prices below $100 for the entirety of the coming year by purchasing the Cal09 $90 calls for only $7.25. Also, the Cal09 $100 calls can be owned for Zero Cost by selling the $65 puts in the same tenor. This strategy puts no premium at risk at or above $65 and provides unlimited upside protection above $100.

Singapore, 09:30

Cheaper Premiums Allow Hedgers to Enter New Protection at Discounted Levels

Yesterday saw a sharp turnaround in energy markets as traders begin to focus on the possible after-effects of the current banking/liquidity crisis. The trickle-down effect to the main-stream economy is expected by many analysts to cause several quarters of recession in the United States which may spread eastward. Early Asian trade had markets sharply higher, and several producer hedgers entered the market to purchase cheap downside protection in the form of put spreads. These mid-day Asian-hours hedges paid off swiftly as the market sold off sharply during late-day trade in NY.

Implied volatility softened early yesterday, thus allowing consumer and producer hedgers to enter the market today to lock in significantly lower premiums. As the bearish pressure looks to be unrelenting in the short-term, calendar hedges such as the Q408 through 1H09 $60/75 put spread strip are being purchased to protect against a further drop in prices. This strip is currently trading around $4.00, thus providing $11,000 of downside protection per month after the $4,000 average cost is factored in. To gain the full $15,000 per month of protection, bearish hedgers can make the trade zero-cost by selling the $96 call in the same tenor. This hedge offers no premium at risk below the $96 level.

Singapore, 07:40

Commodities Retrace on Bullish Government Announcements

Commodity and equity markets rose sharply yesterday as the governments of leading industrialized nations pledged to support the struggling global financial system. Metals and energies in particular rose firmly, with November WTI crude oil pushing back above the $80 level to its current level above $83.00. Helping the recent bullish turn is the unequivocal statement by several of the more hawkish members of Opec (Iran, Venezuela and Algeria) to request for a cut in production at the cartel's emergency meeting next month in Vienna. Several Opec members have argued that the world is currently oversupplied by as much as 0.5m barrels per day.

Yesterday's sharp move higher served to increase implied volatility during Asian trading. While the move was quite convincing from the bullish perspective, doubts remain over the economic stability of large consumer nations. Focus is now on the extent to which the recent financial turmoil has damaged commodity demand for the near-term. Thus, the rally may be short-lived and downside producer hedges remain in the spotlight. Using Average Price Options, the November through December WTI $80/60 put spread strip is trading around $4.25. That's max exposure of $4,250 per month with a total payout of $31,500 should both months settle below $60. The trade can be made costless by selling the $90 call in the same tenor. This hedge would provide $40,000 of downside protection with no premium at risk below $90.

Singapore Fuel Oil hedgers looking to protect their downside can combine the above strategy with the sale of the 180 Fuel Oil Swaps in the WTI/Fuel Oil crack, currently trading around $19.00.

Singapore, 08:30

Financial markets recover - a sigh of relief

In a quasi-holiday (Columbus Day), crude oil markets followed the equities market higher, with volatility easing in tandem. Crude volatility eased much less than other financial markets and a follow-on Tuesday would indicate even lower levels.

For those using 3-way strategies (selling net options), there may still be time to capture good premium. Inventory hedge strategies for November include the 65-75 put spread versus the 96 call for zero cost. A move down due to bearish stats Wed would benefit from the decrease in prices and potential for further volatility easing.

We expect the US Treasury to firmly step in and buy US bank equities. This will prompt a follow-on rally in the DJIA after a huge 10% plus up day Monday.