Chesapeake Energy (CHK, $11.84, down $2.26) continued its free-fall today and is feeling the pinch from falling energy prices and increased inventories. Last Friday I mentioned the company was issuing more shares to raise nearly $2 billion in capital which would dilute shareholder value. Chesapeake plans to use the proceeds for core operations and acquisitions but the current environment has left the company short on cash.

The company is in the process of developing “shale sand projects” but has been forced to cut its budget through 2010. These projects are aimed at retrieving natural oil and gas but with demand dropping, Chesapeake may have to hold off on such projects.

Option implied volatility on the stock continues to rise and I had mentioned all signs were pointing to a break below $11.99. We witnessed that today as the stock hit a low of $11.50 and closed below its previous 52-week low. Not a good sign if you are bullish.

Th good news is that we weren’t bullish on Chesapeake Energy as we were expecting more downside. The December 17.50 puts (CHKXW, $6.20, up $2.25) are deep-in-the-money which means the options will trade dollar for dollar if the stock continues lower.

These options opened at $1.65 last Friday and continue to add on big gains for us. We have raised our stop along the way and at last check we had it at $3.50. Let’s go ahead and take it up to $5.75. The December options expire in two weeks so there is still time for the stock to drop even further before the puts expire. However, if the stock rebounds we will close the position if our stop is taken out.

Rick Rouse