Why wait for a few more percentage points to take the gain, as several readers rightfully asked in emails and blog posts? I had said 50% for “silly psychological reasons” as I replied to one reader – i.e. that was the gain that would have offset the Nortel loss in one account.

Over the weekend, I read halfway through Timothy Sykes’ book, An American Hedge Fund, and came across a passage where he similarly held out for a few more points because that would exactly offset his loss on previous trades. His experience highlights the utility of having more objective criteria for buying and selling. He writes:

“I promised myself that I would hold [my short position] until I broke even from the two earlier trades. My paper profit now surged to $27,000, but I still didn’t take it. Within minutes, it turned into a $6,000 paper loss. I couldn’t chance another reversal, so I decided to cut my losses. Unfortunately, the quick reversal scared many other short sellers into trying to cover too … and I found myself chasing the stock higher … and was finally out … with a $28,600 loss.”

Preet Banerjee emailed in with his hedged trade on HOD. When oil was near $140, his mock portfolio bought HOD and several energy stocks to arbitrage the undervaluation of oil stocks relative to the commodity. That turned out well, he reports, and now he is unwinding the trade.

But I plan to put in a sell order for the ETF next week if and when a gain of approximately 50% is reached. The price of oil could keep falling to the marginal cost of production, which the LEX column in the Financial Times of London says is “around $70 a barrel.” But market forces rarely drive prices to their equilibrium in a straight line and if a reversal came now, it could be demoralizing to watch the gain evaporate when loses are piling up elsewhere thanks to the bear market.

Moreover, market forces are rarely left unmolested. Indeed, next week OPEC is meeting to discuss production cutbacks. And political disturbances could result in an upward spike. That would be a good time to go short again with the Horizons BetaPro NYMEX Oil Bear Plus ETF.

Indeed, chances are good the stocks could then be the cheapest they’ll get prior to the recovery phase. Declines have gone far already as can be seen from the following price declines over the past year.

FedEx -22%
Ford -40%
Winnebago -60%
AMR Corp. -75%

Current events supporting oil include the threat of a strike on Iran by Israel and turmoil in Nigeria. And with the U.S. driving season entering its peak period, prospects for a correction certainly do not appear to be in store just yet.

But after August, Chinese authorities should let domestic prices rise closer to world levels, adding to “demand destruction” occurring elsewhere in the world. Chinese authorities ought to take such measures now but don’t want to risk having social unrest mar the hosting of the summer Olympics. Tougher measures will have to wait until after.

As such, an interesting investment to consider is the Horizons BetaPro NYMEX Oil Bear Plus exchange-traded fund (ETF). Listed on the Toronto Stock Exchange in Canada under the symbol HOD, it double shorts the price of oil, i.e. tracks “two times (200%) the inverse (opposite) of the daily performance of the NYMEX light sweet crude-oil futures contract for the next delivery month.” In the U.S., there is the UltraShort Oil & Gas ProShares ETF, which “returns 200% of the inverse of the performance of the Dow Jones U.S. Oil and Gas Index.”

The double-short oil ETFs let an investor short the oil sector without the hassle of an actual short trade on futures contracts or oil stocks (or buying put options). One can sit on the ETF position in a non-registered account or even a registered retirement account for as long as it takes, without the bother of margin calls or time decay.

That will come in handy. If oil spikes up more from here, one can just wait it out – although the paper loses could easily tally 20% to 30% given the volatility and leverage at work. Longer term, however, as the price of oil normalizes, the same volatility and leverage should erase the losses in short order and go on to provide some nice gains. Actually, as part of one’s strategy, it’s tempting to consider averaging down on the double-short oil ETFs if oil prices shoot up again from current levels. Disclosure: I own HOD (as of today).

But when I looked at the possibility of buying contracts, the native hue of resolution was sicklied o’er. Not with the pale cast of thought but disappointment over the depth of the market. It’s difficult to place a bet of any significance.

The current ask price is 36.2. But there is only one contract on the order book and given a point equals 10 cents, it can be purchased for $3.62. At the next ask price of 36.3, there are 5 contracts available, costing $18.20 in total. Indeed, one can buy all of the 200 or so contracts offered at ask prices up to 39.0 for less than $800.

Then there is the warning in the rules section on the need to check the legality of trading on Intrade.com in your country of residence. If there are any doubts, “then you should not use our service until you take suitable professional advice,” says the website.

That’s a shame. It could have been fun playing these prediction markets. Furthermore, the ones with low volumes, like the recession market, will not necessarily live up to the findings from academic studies that prediction markets provide better forecasts than opinion polls.

I don’t know. What I do know is that hedging against this risk might be a good idea even for the Canadian market as highlighted by today’s drop in the broad index — even though the price of oil climbed yet again.

In Canada, put options on the iShares CDN S&P/TSX 60 exchange-traded fund are one solution. Right now, such put options can be purchased relatively cheap. The Montreal Exchange’s Implied Volatility Index (MVX) did tick up today but the present reading, near 17.25, is still considerably below the peak of 32 reached in January.

- gas prices have lagged crude oil prices
- rig count still low in Canada due to cost inflation and strong C$
- U.S. production faces high depletion rates and less accessible gas fields
- Asia and Europe bidding up prices of liquefied natural gas (LNG)
- North American LNG facilities unlikely to come on stream before 2011
- natural gas substitutes (e.g. coal) hitting new price highs
- speculators remain net short natural gas in contrast to crude oil

So let’s stick with the gas stocks and exchange-trade funds (ETFs) mentioned in previous posts. The Claymore Natural Gas Commodity ETF is up about 30% since the Feb. 15/08 post Got GAS. The United States Natural Gas ETF is up a bit more over the same period. Encana shares have gained nearly 50% since the Aug. 20/07 post, Playing the natural gas cycle. But it looks like there is even more price appreciation coming, according to BCA Research.