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This column was originally published on RealMoney on Oct. 3 at 10:45 a.m. EDT. It's being republished as a bonus for readers. Click here for a free trial to RealMoney .

The energy complex is getting hit hard as oil slips below $60 per barrel, and this is driving options action across the sector.


Oil Service HOLDRs

(OIH) - Get VanEck Vectors Oil Services ETF Report

has gapped down some 3.5% and is threatening to break support at the $120 level. There is heavy put volume in the $120, $125 and $130 strikes, but it is all focused on the near-term October series.

Likewise, in the

Spyder Select Energy

(XLE) - Get Energy Select Sector SPDR Fund Report

, the volume is focused in the at-the-money October $50 and $51 puts.

The list of individual names getting hammered is too long to work through, but suffice it to say that drillers, refiners and large integrated players are all sharply lower and seeing an increase in implied volatility.

Recent posts have mentioned that my preferred approach to playing this group was to get long volatility/gamma by either shorting stock and buying calls or buying puts against long stock. In both cases, the key was to use a ratio that would ensure the position's delta would become more negative or bearish as prices decline, and more positive or bullish as prices rise.

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This has been working as the group has provided sufficiently large price swings to trade the underlying stock and offset the time decay of the long options. But unfortunately, I had been looking at starting with a slightly positive delta or bullish bias, meaning that even with this morning's big decline, I don't have that much ammo for buying dips, merely get the position back toward a delta-neutral position.

What's interesting is that this morning, one of the big brokerage firms came out with a long-term bullish call for oil prices heading into 2007 based on macro supply/demand picture. So does today offer an opportunity to step in and set up a longer-term bullish play in the sector?

One strategy I'll be looking at is getting long some calendar spreads. With stocks like


(SUN) - Get Sunoco LP Report

testing support at the $60 level, the purchase of selling/buying the November/March $65 calendar (that is, selling November and buying March) for a net debit of around $4.50 might be attractive. Assuming prices can stabilize over the next month, it gives some flexibility: either end up outright long the March or roll the calendar into the December series to help reduce the initial cost and risk.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback;

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