Volatility holding - Don't wait for the unexpected

When we look at volatility levels, it is often difficult to decide when it is well offered versus how cheap it might get. We have seen volatility decrease lately (to the low 40s), but the fact is, it could go lower. In these situations, using spread strategies continues to rule for buy and hold trades. For example, the Q4 115-125 call spread (Asian) is offered at $2.65. This is a low cost hedge for the remainder of the year for consumers. On the other hand, short term strategies or long physical (wet barrel) or inventory hedge players are better off buying outright options (in this case puts) to protect against a strengthening USD that might put more pressure on crude down to $100 or below.

Short term, we see potential risk from Hurricane Ike. This may put pressure on crack spreads and could also give some support to NG, which has experienced a very bearish market, with volatility in. We are suggesting a long futures strategy in NG with a put stop-loss for consumers.

It is always better to hedge when the market is stable and fear has subsided.

NY, Fri 430 PM EST.

Unanswered Questions Result in Rangebound Trading

Energy prices remain in limbo as the market awaits further news on possible damage done to Gulf of Mexico production facilities in the wake of Hurricane Gustav. The storm season has reached its peak, and once traders sense that another year has passed without major damage, prices may fall further. In the U.S., as well as several other European nations, oil stocks are sitting comfortably at the 10-year average, thus fueling speculation of an imminent production cut by Opec. What is more likely than a stern announcement is the cartel slowly lowering levels back to the original target rates. In fact, this may have already begun.

With so many questions regarding supply and demand unanswered, the market may continue to vacillate at 6 month lows until some answers are forthcoming. The recent range-bound trading has resulted in a sharp decrease in option premiums which consumer hedgers would be wise to take advantage of. Using Average Price Options (Asians), it is possible to own the WTI $110/125 call spread from September through December for Zero Cost by selling the $102 put in the same tenor. This trade allows the hedger $15,000 per lot per month of upside protection with no premium at risk above the $102 price level.

Consumer Strategies Highlighted

Crude oil prices were rangebound yesterday in both Asian and New York trading. While the verdict is still out on Hurricane Gustav's ultimate damage tally, structural harm at rigs and refineries appears to be limited. WTI crude is now trading safely below the 200 day moving average of $111.64 as the market attempts to identify the level where demand is restrained but not destroyed.

Option premiums have become increasingly cheaper in the wake of the volatility caused by Gustav. Consumer hedges in particular are looking quite economical for the remainder of 2008. The September through December $115/125 call spread is currently trading around $2.40. That's $2,400 of total premium at risk per month with $7,600 of protection should the market move back above $125 before the year is out. In other words, if only 1 month in the next 4 settles above the $125 level, the trade produces a profit of $400. Not a bad prospect for consumers considering the market is now down almost 30% in just over a month.

Option Premiums Cheapen

Front month crude oil dropped below $106 in Asian markets yesterday as traders moved beyond the short-term impact of Gulf of Mexico hurricanes. Compared to dire expectations, Gustav looks to have been a nonevent, although further assessment of production facilities is required before this pronouncement can be fully digested by the market. Energy markets appear to be looking for the level that restrains demand growth but does no destroy it and traders are now focusing on a lack of demand going forward due to what looks like a global economic slowdown. On the flipside, energy investor Boone Pickens said yesterday on CNBC that he sees Opec cutting production shortly in order to defend the $100 price level.

Option premiums have decreased significantly in the past 24 hours and consumer hedges have become much more affordable as a result. Zero cost upside protection from the $115 level to the $130 line can be owned from today until the end of calendar year 2008 by selling the $101 put in the same tenour. This trade locks in oil prices at $115 should the market move above that level and provides $15,000 of protection with no premium at risk at or above a price of $101.

Gustav downplayed

Early market action in London sent crude down as low as $105.65 as traders sold on news of lower than expected damage from hurricane Gustav. However, we have yet to see enough data regarding production lost from the shutdowns in the Gulf of Mexico over the last week. Additionally, delays in the Houston ship channel cannot be overlooked. The market did rebound over $110. NG showed very little resilience, ending down close to 70 cents / MMBTU. Consumers had a window of opportunity earlier today. Although some traders are calling for $100 crude, we may not have near term bear market conditions until the weather risk has subsided. The Q4 zero cost collar in WTI (Asian style) is now 100 put vs. 125 call. For the same period, a low cost call spread such as the 115-125 is offered at $3.25

Hedging Focus Moves to Global Economy after Gustav Weakens

Crude oil prices dropped below $111 yesterday as Hurricane Gustav quickly moved from "storm of the century" to probable non-event. More than 96% of oil production and 82% of natural gas production had been shut in, resulting in what many hope to be minimal damage to infrastructure. Traders are now focused on the lack of demand going forward in the next couple months due to a global economic slowdown. Opec's meeting in Vienna next week is also on the radar as Iran, Venezuela and Ecuador voice their displeasure at the recent fall in prices. No output cuts are likely at this juncture, so price may continue downward towards the $100 level.

Producers or physical players needing protection against further moves lower can look to the September through December $110/95 put spread vs. the $120 call using WTI Average Price Options. The put spread can be owned for free in every month remaining in the 2008 calendar by selling the upside call, thus giving the hedger about $8 of leeway should the market move higher. The spread provides $15 of immediate protection per month upon any move lower.

Questions Remain over Gustav's Heading

Traders ended last Friday with growing concerns as to the prospective path of Hurricane Gustav in the Gulf of Mexico. More than 25% of US crude oil production originates in this region, and while Gustav will hit landfall sometime in the next 12 to 24 hours, it may be weeks before the full extent of any enery production infrastructure damage is known. The Gulf region is also a large producer of Natural Gas, and while the storm has resulted in rallies in both crude and gas, it is the natural gas price that has fallen farther over that last couple months, resulting in the current 15 year high for the crude to natural gas price ratio.

Consumer hedgers looking for some cheap protection for the remainder of the hurricane season can still look to the liquid WTI Average Price Options (APO's). The September through December $120/135 call spread can be purchased for Zero Premium by selling the $109 put in the same tenour. This zero cost call spread provides $15 of protection above $120 for every remaining month in 2009. There is no premium at risk at or above the $109 level.