Natural Gas : Seasonal Play Sets Up for Springtime Option Sellers
Weather Players have had a field day with Prices this winter, driving up option premiums. With Seasonal Fundamentals now set to kick in, the table looks set for Put Writers.
N atural Gas is a tough market to call short term. Weather forecasts can bring public speculators to the market in mass – causing wild daily fluctuations, especially during the winter months.
As a futures trader, I wouldn’t touch it.
But if you’re an option seller, this is a fantastic market to ply your trade.
Why? Because the public participation and daily swings provides ridiculously deep out of the money option strikes at healthy premiums . And while specs may drive the daily price whims of this market, it is some surprisingly reliable demand led cycles that drive longer term price direction.
Knowing them can give you a tremendous advantage as an option seller – while allowing you to stay above the “riff raff” of daily market fits and starts.
And as Natural Gas has seen just such a speculator led bout of volatility, prices now appear out of synch with their core fundamentals – and may be in an ideal position to benefit from a strong historical price tendency (although past performance is not indicative of future results.)
This could provide a lucrative play for option sellers this month. But first, lets understand this seasonal price tendency and how it is setting up this year.
Seasonal Cycle of Natural Gas Demand
Natural gas, like many commodities, has certain times of year where demand is higher or lower. In gas, these cycles are based on the weather. Winter is the peak time for natural gas usage for heating needs. But Natural Gas also has a secondary demand season. In summertime, electricity demand surges as US consumers power up air conditioners. As many electric plants in the US are now powered by natural gas, demand for this commodity surges too.
But if you’ll remember from your “seasonal” chapters in The Complete Guide to Option Selling , price often precedes consumption. This is because commodities futures values are more reflective of prices at the wholesale level, not at the retail level. Thus, natural gas prices have historically tended to peak in the fall and again in early summer, well ahead of the peak retail demand periods.
…even though US springtime can be a benign time for weather, it can bring a surge in demand at the wholesale level for Natural Gas
In the winter months, while retail demand is at a peak, wholesale demand is often slack. This because distributors have typically already accumulated enough supply to meet winter demand needs. Thus, it is not uncommon for natural gas prices to show weakness through winter months . This tendency, of course, is an overall one and can be interrupted by exuberant speculators betting on weather, as we’ve seen in 2018 (more on that later.)
By the end of winter, however, distributors’ supply levels are often depleted. Thus, they begin aggressively rebuilding inventories to both meet summer electricity needs but also next year’s heating needs. As a result, even though US springtime can be a benign time for weather, it can bring a surge in demand at the wholesale level for Natural Gas . This is why on average, Springtime can be a time of firming natural gas prices.
This tendency is illustrated in the Seasonal Tendency chart below:
Natural Gas Prices have historically tended to strengthen into Spring and early summer as distributors begin re-stocking inventories to meet summer demand needs.
2018 Weather Bears May have Overplayed Hand
While seasonal average charts can be of tremendous benefit to option writers, you must remember that these are just average tendencies. Markets can and do vary widely on price patterns in any given year. This is often driven by the weather speculators discussed early.
2018 saw a counter seasonal surge in gas prices from late December through early February. This was based largely on a series of highly publicized winter storms in the US during that time period. Large Funds (that primarily use trend following systems) helped drive the rally.
Shovels weren’t the only thing that came out during this year’s winter storms. A slew of media coverage (and the newly created tradition of “naming” winter storms) brought out the public to speculate on natural gas prices as well.
However, when the storms passed and weather forecasts began to mitigate in February, the market found itself perilously overbought. Funds and small speculators liquidated aggressively.
Would you want to try to trade this market on a daily basis? I wouldn’t. The market’s trough to peak rally above $3.60 per mbtu looks extreme on a daily chart. However, do you think this would have bothered you much if you were short the 5.00, 6.00 even 7.00 calls in this market? Probably not.
That’s why we consider natural gas an “option seller’s” market.
This brought the market right back down to where it “should” be this time of year.
Or should it?
Weather may look benign. But the supply situation in natural gas does not appear to be bearish. In fact, headed into peak demand season in natural gas, the market could now actually be underpriced.
The liquidating bears could have overshot.
End of Winter Supplies Lower Than Normal
Specs and funds unwinding long positions are most likely missing the bigger picture. Natural Gas was overbought in February for sure. But inventory levels are such that could support the beginning of a seasonal rally in March or April.
At the time of this writing, the latest EIA Natural Gas Storage Report shows 2018 inventory levels at 1,884 billion cubic feet (bcf), down a full 23% from this time last year anddown 19% from the 5 year average. Over the last 4 weeks (from time of writing), natural gas storage levels have declined by 700 bcf.
2018 Natural Gas Supplies are down 23% from this time last year and 19% lower than the 5 year average. (Also, note how inventories tend to decline into the end of winter and then begin to rebuild into the summer months. This “re-stocking” period is largely responsible for the seasonal price tendencies of natural gas.)
Record Demand Projected in 2018
While supplies have dwindled this winter, the EIA projects record US demand for natural gas in 2018. This due not only to increasing industrial production, but also do to more older coal fired electrical generating facilities being replaced by modern nat gas powered plants. The chart below illustrates the EIA forecast.
Natural Gas consumption is projected to hit a record in 2018.
Conclusion and Strategy
While we are not in the business of calling “highs” or “lows” in the market, the natural gas market now appears to be in prime position to take advantage of a seasonal tendency for higher prices. In addition, fundamentals appear supportive for price firming into the spring and summer months of 2018. Supplies are below 5 year averages and the demand outlook is strong.
Does that mean we “bet” prices will move higher? Of course not. Option sellers don’t “bet.” All factors appear supportive into Spring. That doesn’t mean prices can’t move lower. That is why, especially in the natural gas markets, we don’t try to predict such things. As option sellers, we don’t have to. We simply pick a point well BELOW current prices, decide the market most likely won’t go there, and then get paid to wait.
In this case, that means selling put options at nicely inflated premiums.
We’ll be selling a series of strikes and strategies for our managed clients this month. However, if you’re not yet a client, you can consider selling the September Natural Gas 2.25 put options for premiums of $500 or better. The options expireAugust 28. Margin requirement is approximately $1,150 per option.
With an August expiration, these options should show significant time decay with any type of natural gas price firming into the Springtime months.
September 2018 Natural Gas
Selling the September Natural Gas 2.25 put option.
The weather players have had their day in January. They have set a nice table for fundamentally based option sellers this Spring. If you’re looking to pack some high percentage premium into your portfolio this month, you may consider taking a seat.
James Cordier is president and head trader of OptionSellers.com, a Tampa, FL based wealth management firm specializing exclusively in Option Selling Portfolios for High Net Worth investors. For more information on managed option selling portfolios with James and OptionSellers.com, visit www.OptionSellers.com/Discovery for a Free Investor Information Pack. (Recommended Opening Deposit US $1 MM)