Call Premiums Still Inflated in Bearish Natural Gas Market

Call Premiums Still Inflated in Bearish Natural Gas Market
Oct

13

2017

Call Premiums Still Inflated in Bearish Natural Gas Market

Historic Volatility in Natural Gas is offering some attractive opportunities for “Fading the Herd” this Autumn

“Buy Natural Gas heading into winter.” Its an old trading axiom that seems to make perfect sense. After all, colder weather should increase demand, making prices go up. It only makes sense to buy heading into winter and hold on for all of those easy profits, right?

Wrong.

Such pop market analysis may attract the neophyte. But real analysis of the Natural Gas market presents quite a different story – a story backed up by historical price data.

It is true that retail gas prices may very well increase in the winter. But the Futures markets are most often based on wholesale supply and demand, not retail. And the supply demand cycle there is substantially different.

The Fundamental Cycle of Natural Gas

While retail demand may very well be highest in winter, wholesale demand is highest in the fall. Why? Autumn in the northern hemisphere marks what is known as injection season. That means that is when distributors are accumulating supply, injecting it into storage tanks to meet winter retail demand. This demand from distributors can often support natural gas prices. Wholesale demand tends to peak during the month of October but often continues well into December.


…ironically, it is not uncommon to see natural gas prices slide lower right into the very heart of winter.

This seasonal phenomenon has historically been supportive to prices into early autumn, but then reverse the price trend as the pace of injections slows down into late fall and winter. As supplies hit levels deemed adequate to meet winter needs, anxiety fades from the market and prices tend to fall.

Thus, ironically, it is not uncommon to see natural gas prices slide lower right into the very heart of winter. This tendency is illustrated on the seasonal chart below.

GRAPH: Natural Gas 15 yr Seasonal

Natural Gas Prices have tended to weaken into the winter months as the pace of distributor storage injections slows.


Natural Gas Prices 2017

While the historical tendency has been for prices to rally into autumn, that has not been the case this year. This could be because prices already put in a high in September. It could be because prices will top later in the year (as they did in 2016). Another reason could be the historically high level of supply in 2017.

At the time of this writing, Natural Gas supply in the US stood at 3.595 trillion cubic feet (tcf). While not a record, this hovers near a historical high level for this time of year.

GRAPH: EIA Working Gas in Storage Current Yr vs. Historical Highs and lows

Natural Gas supplies are near historic highs for this time of year.


Conclusion and Strategy

Both the fundamental and seasonal outlook for natural gas prices remains bearish for 2017 . However, in mid-October, the market appears oversold and is vulnerable to upside prices rallies in the next 4-6 weeks.

The good news is, bearish supply levels and waning distributor demand will likely cap most technical rallies. The better news for call sellers is this: Historic volatility in natural gas allows for one to sell deep out of the money calls even after the price decline of the past several weeks.

Seasonal tendencies have been for prices to remain weak into February in a typical year. March Natural Gas options expire in February , making them a perfect choice for this trade.

We were able to squeeze off strikes at levels twice the current price of natural gas earlier in the month for managed accounts. OptionSellers.com will continue to harvest premium in the natural gas market for managed clients through Q4 2017.

However, self-directed traders can still look to take premium in the coming weeks.

Aggressive traders can consider selling the March Natural Gas 5.00 call options for premiums of $600 or better. Margin requirement is approximately $1700. Thus, a worthless expiration would produce an approximate 35% return on capital in 4 months’ time.

More conservative investors could wait for a technical rally over the next 2-4 weeks to target slightly higher strikes at similar or better premium (although there are no guarantees such a rally is forthcoming)

March 2018 Natural Gas

GRAPH: March 2018 Natural Gas


March Natural Gas Chart Showing 5.00 Strike Price Level


Popular axioms and what seem like “common sense” trades aren’t always what they seem to be in commodities. Fading the herd is most often the wiser choice. Public speculators will be excitedly opening wallets to purchase call options this fall, looking for big winter price rallies in natural gas. “Cold weather” headlines will convince them of the wisdom of this and potentially even rally prices for a spell. Any such rallies, however, will likely fall well short of where they need to be for these speculators to make any money. But that is their business.

Yours is obliging their wishes and taking their money.

Following the strategy above can help you do just that.

Happy Halloween.

-James

For more information on managed accounts with James Cordier and OptionSellers.com, visit www.OptionSellers.com/Discovery to get a Free Investor Discovery Pack. (*Slots are limited. Recommended opening deposit US $1 MM)

  1. Love this piece. I have been trying to do some research on my own as well from info you provided in your book and wrote calls on this at the 6 and 6.5 strikes about 2 months ago. I do not trust myself to manage a large account on my own as my emotions always get in the way, so I just opened up an account with you guys and am excited about watching you and learning from you starting next month.

  2. Tom Dygon Says:
    October 15, 2017 at 6:00 pm

    Can you please more fully explain “March Natural Gas 5.00 call options for premiums of $600 or better.” Are you indicating I should be able to sell EACH call option for $600?

    Tom

  3. Thank you again for the great article on NG. Just as a side note I would love to see you folks comment more on other not so common markets (sugar, OJ, cotton, milk, cattle).

    • Michael Gross Says:
      October 16, 2017 at 2:23 pm

      Hello Carlos,

      Thank you for your feedback. We typically are writing about markets with the highest volume options and/or the markets where we feel writing options offers the investor an advantage. For various reasons, some of the markets you mentioned do not meet that profile. But a couple may in the future and we never rule anything out completely. With the exception of milk, we have traded all of the markets you mentioned at one time or another.

      Regards,
      Michael

  4. JMES WOULD A CALL CREDIT SPREAD BE A GOOD CHOICE/?

  5. Unfortunately, most of us do not have the $1M needed to open an account with you. Have you ever considered starting an affordable weekly/monthly advisory service so “small” investors can benefit from your strategies? Thanks.

    • Michael Gross Says:
      October 16, 2017 at 2:27 pm

      Bill,

      Thank you for your feedback. We have been approached many times regarding this type of business venture. However, this would be an entirely separate enterprise requiring our attention and likely more employees. At this time, we prefer to concentrate on growing client assets. As for the future, never say never!

      Regards,
      Michael

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