Market Jitters Result in Flight to Commodities

Energy markets rallied yesterday on the back of a flight to commodities from equities. Risky assets, at the moment being anything that is not gold or energy related suffered enormous losses in volatile trading. Weekly US inventory numbers drove crude prices sharply higher as the effects of Huricane's Gustav and Ike are now being quantified. Although draws were largely expected, crude stocks suffered an outsized dip for the second week in a row, down 6.3m million barrels, a reflection of the sharp weekly drop in imports.

Option premiums remain elevated as a result of the sharp market moves. Consumer call spreads will always be a cheap way to gain upside protection, especially in volatile markets. Using Asian options, the WTI Q4 $100/110 call spread can be purchased for an average price per month of about $2.80, or $2,800 of total premium at risk. This call spread can be purchased for zero cost with the sale of the Q4 $88 put.

Singapore, 08:00

Financial institution instability

Despite a US Fed bail-out of AIG, investment banks such as Morgan Stanley and Goldman Sachs felt the pressure today selling off as much as 40%. Energy prices rebounded as inventory data showed draws in crude, with more expected for next weeks reports. Traders reacted slowly but finally pushed prices higher based on the ongoing Nigerian conflict and short covering from recent sell-offs. Gold rallied sharply also as markets sought quality assets. Volatility remains high as we face one of the most trying financial markets (including commodities) on record. We must stress here that the NYMEX and ICE clearing models used by HCEnergy remain the most sound platforms for credit. OTC/ISDA contracts with companies such as Morgan Stanley could be at risk. We expect more derivative contract flow to move to NYMEX/CME and other cleared exchanges.

During these times of volatility, owning options is the best strategy versus trading futures.

Opportunity for Fuel Oil Traders and Producers to Lock in Downside Protection

Energy prices fell yesterday as markets focused on the looming question of AIG as well as the fall-out from Lehman's collapse. AIG, the world's largest insurer, sponsors the DJ-AIG, a large commodity index which dropped more than 2.7% yesterday as investors moved out $10bn worth of funds this week. Adding to counterparty worries this week was the bankrupty of Lehman Brothers. The impact on the bank's $5bn commodity index busines has yet to be quantified but the past week has displayed, if nothing, the outright dangers of trading OTC as well as the pitfalls of counterparty risk. Trading and clearing on an exchange such as NYMEX enables counterparties to avoid any and all of the current counterparty solvency issues.

Option premiums have increased significantly this week as a result of the market volatility. Producer put spreads present a cheap way to gain downside protection against further violent moves. Using Average Price Options, the WTI Q4 $90/75 put spread strip can be purchased for only about $3.70 per month. That's $11,100 of total premium at risk, providing $33,900 of downside protection throughout Q4. The strategy can be made costless by selling the Q4 $101 call strip.

Singapore 180 Fuel Oil hedgers looking to protect their downside can combine the above strategy with the sale of Fuel Oil Swaps in the WTI/Fuel Oil crack, currently trading around $9.19.

Singapore, 08:35

Market Plunge Presents Opportunities

Fundamentals may have taken a back seat for several days as traders attempt to adjust postions amidst a plunge in both commodity and equity markets. Yesterday saw crude oil down more than 35% in only two months time while the dollar seemed to have no support as well. Lost in the economic turmoil was Mend's openly declared "oil war" in Nigeria as a Royal Dutch Shell installation was attacked.

The current drop in commodity markets provides consumers with an excellent opportunity to lock in fuel prices more than 35% off the all-time highs. The WTI Q4 2008 $100/130 call spread can be owned for only $3.00 per month using Average Price Options. This call spread provides a $27,000 payout per month if the market rallies back to $130 with only $3,000 of total risk. The call spread can be made costless by selling the $88 put strip.

Singapore, 08:05

Financial turmoil forces liquidation

Overnight news confirmed the intention to sell ML to Bank Of America while Lehman Brothers filed for Chapter 11 to protect its' solid business units. AIG also suffered pressure to sell without any back up financing in place. The US fed is standing firm regarding no bail-out or back stop facilities.

While financial markets are under pressure, there may be some forced liquidations in the markets from ML customer or even index funds. Refined products are down more than 20 cents this morning, providing excellent opportunity for heating oil buyers to lock in a Q1 300-350 call spread for 13 cents/gallon. Crude oil volatility has popped as high as 55% for Wed expiry. There is plenty of room for the market to move $5 by Wednesday.

NY, 0900

Questions Remain as Ike makes Landfall

Energy markets traded tentatively on Friday as Hurricane Ike's ultimate landing point this weekend in Texas remained largely in question. On Friday, traders considered that up to 20% of US refining capacity may be in danger as well as access to the Houston shipping channel. Preliminary reports surfaced late in the weekend suggesting the storm may not have wreaked quite the havoc many analysts were predicting, however, final analysis of damage done to refining infrastructure and Houston's vital transport network will take at least a week.

Producers worried about support being removed from the market and looking to quickly lock in crude prices above the $100 level can take advantage of cheap option strategies using Average Price Options (Asian options). A producer price floor of $100 can be owned in the 4th Quarter of 2008 (Q408) for only $5.90 per month. This strategy can be made costless by selling the $103 call and locks in the hedger's crude oil price between $100 and $103.

All eyes on IKE

The storm should put even more pressure on refined products and cracks. We have seen cracks widen and volatility move out beyond 60% in RB. Physical players with inventory could sell some calls and collect big premium here.

As a lower risk trade, long inventory heating oil players could buy the Oct Euro heating oil put spread 260-280 for 7 cents or sell a 307 call in combination, making the whole structure zero cost. At-the-money is 293 here.

Gasoline is another story. The Oct-Nov spread is 1650 now down from 2000 today. We have heard that physical gasoline has traded as much as $1.22 / gallon over NYMEX, which means there are some short squeezes in the market. That spread could go out again. Our suggestion would be to own some call spreads for Nov Euro (or Oct Asian), which would not be subject to too much volatility compression. If the refinery complex is down for a few weeks, the compounding effects of low inventory and refinery downtime could have a dramatic effect.