But investors need not despair. We’ve witnessed several corrections in the energy patch over the past three years, and each has provided us with an outstanding buying opportunity. In my view, we’re near yet another golden moment.

The main reason for the move is the extreme volatility in the oil and natural gas commodity markets over the past three weeks. Not only have both commodities seen sharp declines, but they’ve also seen some of the largest daily moves ever.

The main driver of the selling is concern about weakening US oil demand. Based on Energy Information Administration (EIA) data, it appears that US demand is off somewhere in the 2.5 to 3 percent range this year–500,000 to 600,000 barrels per day (bbl/d) of lower oil demand. This is in the context of a global oil market comprising more than 85 million bbl/d.

And according to the International Energy Agency’s latest monthly Oil Market Report, global oil demand is actually set to grow in 2008 by around 900,000 bbl/d. The 500,000 bbl/d decline in the US will be offset by an additional 700,000 bbl/d in consumption from Asia-Pacific, a 400,000 bbl/day increase from the Middle East and further gains in other emerging markets.

The US inventory picture has become more bearish over the past month, though it’s far from a glut. Oil inventories are actually below average for this time of year.

And consider the discrepancy between Brent and West Texas Intermediate crude (WTI). Brent is the key international oil standard, while WTI is the US benchmark crude. WTI is a higher grade of crude oil, so it typically trades at a $1.50 to $2.00 premium per barrel. But Brent currently trades at a $1 premium to WTI, suggesting the international oil market is tighter than in the US. My base case remains that oil will trade in a volatile range between $120 and $150 per barrel for the remainder of 2008. Short-lived spikes on both sides of that range are possible.

The selloff in natural gas and coal remain even less explicable based on fundamentals. Gas inventories remain below average for this time of year, and natural gas demand isn’t particularly sensitive to economic growth; the EIA continues to forecast growth in gas demand for 2008 and 2009. I highlighted coal in the last issue of TES, so I won’t belabor the point here.

The primary factors underlying the energy selloff aren’t fundamental but technical. Some institutional players decided to take profits on their big winners after the second quarter wound to a close; energy stocks were some of the only winners in the global stock markets in the first half.

The selling appears to have spooked other traders into panic. The panic is palpable when you look at the huge spikes in volume we’ve seen in key energy stocks over the past few days.

But I’m already seeing signs of that panic selling abating. A perfect example is exploration and production (E&P) giant XTO Energy (NYSE: XTO). The stock traded down Thursday close to 5 percent intraday before rebounding to close higher on the session. The volume traded was a record 55.6 million shares.

Against this backdrop, the obvious question is what to do from here. First, in the June 12, 2008, flash alert, Unsteady as She Goes, I recommended using options to hedge six of the biggest winners in the three portfolios. I then followed that up in early July by reiterating that recommendation and urging subscribers unwilling to execute the options trades to book partial gains. If you took the options hedge recommendations, you’ve avoided much of the recent selling pressure entirely. Those who did partial sales of big winners have weathered the storm reasonably well.

For those who took my recommended options hedges, I’m now recommending what options traders call “rolling down your hedges.” It’s not a complex trade, and this technique will effectively increase your upside exposure to the stocks you’ve hedged while allowing you to retain a measure of downside protection. I’ll provide a more in-depth explanation of the trade in an upcoming issue.

I’m also looking at a number of stocks as a possible portfolio addition over the next few weeks. Stay tuned for details in upcoming flash alerts and issues.

Please note that you should only follow the advice related to options if you took the options hedge recommendations detailed in the June 12 flash alert. New subscribers unfamiliar with options insurance can find a more-detailed explanation in my free special report, The ABCs of Options to Hedge Risk. Here are my specific recommendations on the six stocks mentioned in the June 12 and July 16 flash alerts:

Peabody Energy (NYSE: BTU)–Sell the Peabody Energy December $75 put options (BTU XO) for around $1,670 per contract, and hold on to the December $105 call options (BTU LA) you sold. By selling the puts, you’ll realize a profit of around $600 per contract. Buy the December $60 put options (BTU XL) for around $850 per contract.

Weatherford International (NYSE: WFT)–My recommended stop on Weatherford was touched yesterday, handing us a profit of just under 45 percent since my recommendation last year and closer to 60 percent if you took my advice to book partial gains.

If you took my recommended options hedge, you should have canceled that stop order and will still be holding Weatherford. Continue to hold both Weatherford and the put options hedge.

If you did get stopped out of Weatherford, I recommend you jump back into the stock. Weatherford was hit in the wake of its earnings report, even though the company actually offered upbeat guidance for 2009 growth. Weatherford remains the fastest-growing oil services stock in my coverage universe, and I doubt it will continue to trade under 40 much longer. I’m setting my initial stop recommendation at 25.

Sasol (NYSE: SSL)–Sell the December $60 put options (SSL XL) for $1,270 per contract, booking a $470 gain per contract. Buy back your position in the December $70 call options (SSL LN) for $75 per contract, booking a gain of about $300 per contract. Buy the December $50 put options (SSL XJ) for $570 per contract.

Nabors Industries (NYSE: NBR)–Nabors has reported solid earnings and is being hit simply because of general selling in the energy patch. The stock has been, until recently, above my buy target. This marks an outstanding buying opportunity for those not yet in the stock to buy in at a favorable level.

For those in the options hedge recommendation, simply continue to hold the December $40 put options (NBR XH).