Natural Gas Special: Seasonal Tendencies tell Put Sellers to Get Ready
With all of the recent media coverage of the crude oil market, you may have forgotten about the long lost neglected cousin in the energy markets: Natural Gas.
Like its more famous relative, it has been plagued by high supplies and low prices. But unlike the crude market, it doesn’t get the glamour.
For option sellers, that’s just fine. Because natural gas has one of the most consistent seasonal tendencies of any commodity. While crude is a global market, the US meets most all of its domestic gas supply needs from North American production. This can make supply side price analysis a simpler matter. But for seasonal traders, demand is what drives the car. And this car could be getting ready to make a hard left turn.
The Real Seasonal in Natural Gas
As you may have read in our book, The Complete Guide to Option Selling 3rd Edition, (McGraw-Hill 2015), seasonal tendencies can play an important role for commodities option sellers. The problem is, most traders and investors don’t understand seasonal tendencies and what really makes them work.
As we explained in our November piece on Natural Gas (Head Fake for Natural Gas Traders 11/14/15), neophytes may assume that gas prices should rise in winter time because that is when demand is highest.
But that is most often not true. Why? Because in commodities, price precedes consumption. Commodities futures prices at the NYMEX and other futures exchanges most often take their cues from wholesale supply and demand, not retail supply and demand. Thus, as we explained in November, wholesalers begin building inventories for winter in late summer. Wholesale demand (and thus prices) are most often stronger in the fall. By winter, inventory targets have usually already been achieved. This means wholesale demand (and thus prices) ironically often weaken right when retail demand is ramping up (despite media focus on how “cold” or “warm” it is this week.) For the most part, this held generally true in late 2015, early 2016.
Therefore while you may still concern yourself with icy roads and shoveling snow, the natural gas market is already starting to think about summer.
As early as March, wholesale distributors once again begin accumulating inventory to meet excess electricity demand in the summer (primarily due to increased electrical consumption from air conditioners.)
This period of wholesale supply accumulation is known in the industry as “injection” season – aptly named as this is when new gas is being “injected” into storage tanks. Injection season has often been associated with rising natural gas prices. This has often proven true regardless of the absolute price of natural gas or the absolute level of supply currently on hand.
The seasonal chart below illustrates this tendency.
While past performance is not indicative of future results, Natural Gas prices have historically tended to strengthen during supply injection season.
A Bullish Technical Set Up
In addition to historical price tendencies, natural gas is exhibiting a classical bullish formation on the chart. While we don’t place an inordinate amount of weight on technical set ups, this classic inverted head and shoulders formation certainly coincides well with the seasonal tendency.
Natural Gas (Daily Continuation)
Technicians may note a classic inverted head and shoulders formation on the Natural Gas chart. This is coinciding with a seasonal tendency for a surge in natural gas demand at the wholesale level.
Supply Side Fundamentals
It’s hard to make a bullish argument for natural gas supplies right now. The latest EIA figures put total US storage at 2.934 trillion cubic feet (tcf) – 17.9% above the 5-year average and near a historical high for this time of year.
Natural Gas in storage drops as winter heating usage consumes supply. In the spring, inventory building begins anew. This results in higher demand at the wholesale level and in turn, has often been associated with higher natural gas prices in the Spring.
However, as we learned earlier, natural gas supplies ebb and flow with the seasons. Right now, we’re approaching (believe it or not) the end of winter heating season. This is drawing down natural gas stocks. In a few weeks, distributors will begin re-stocking their inventory. This transition period from falling wholesale demand to rising wholesale demand has been most responsible for Spring price increases in years past.
Outlook and Strategy
Natural Gas has a strong seasonal tendency for higher prices in the Spring. An impressive chart pattern is hinting that prices may be exhausted on the downside and ready to begin moving higher.
Does this mean the next great bull market in Natural Gas is around the corner? Probably not. Burdensome outright supply will be a headwind for natural gas bulls for some time to come. Like crude oil, natural gas production in the US has surged in recent years. 2016’s El Nino has brought warmer than normal temperatures to much of the US this winter, despite some high profile winter storms. This will be enough to give bulls some pause.
At the same time, seasonal patterns have tended to hold true regardless of outright supplies.
So what is an investor to do?
I wouldn’t try to trade the futures here. While seasonals and charts point higher, this market is still subject to downdrafts, especially given the supply situation.
That being said, remember that as an option seller, you don’t have to pick what the market is going to do – only what it is not going to do. Natural gas prices are already near 16 year lows. It’s hard to see them making a sustained dive lower heading into peak spring demand season.
For that reason, selling put options beneath the November lows looks like a solid strategy at this point in the cycle. We favor the July and August contracts for best balance of premium vs. time decay.
Volatility could be better for option sellers right now so we recommend waiting for pullbacks to take premium. Selling puts, however, gives the market plenty of room to move and still keeps you in the game long enough to take advantage of a seasonal push higher – or simply a stabilization of prices.
That’s high odds investing.
James Cordier and OptionSellers.com work directly with high net worth investors through their managed option selling portfolio offering. If you want to target high performance, high odds investing or seek real diversification from equities, this portfolio may be for you. For our Free Investor Discovery Pack go to www.OptionSellers.com/Discovery or call 800-346-1949 to schedule a prospective investor consultation. (813-472-5760 from outside the US.) Recommended investment is US $1 MM.
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.