Are Natural Gas Bears Being Lulled Into a False Sense of Security?
Fundamentals
It's been a tough go being a bull in the Natural Gas futures market, as the commodity has been in a bear market since the end of the 2008 commodity price surge. However since April, it looks as though the market has entered a period of price consolidation, with the July contract mired in a relatively narrow, at least by natural gas standards, 60-cent range. Conflicting fundamentals might be behind the recent price stagnation, as above average amounts of gas in storage is countered against potentially rising demand for electricity generation as we enter the prime cooling demand months of summer. Natural Gas in storage here in the U.S. now totals 2.165 trillion cubic feet (tcf) as of May 14th, which is 16.6% above the five-year average. In addition the number of rigs used in Natural Gas drilling has also increased, now totaling 969, which is up 18 from the previous week. So with the supply side still looking very bearish, one would think that those holding short positions would feel confident with their positions. However, anyone who has studied the history of the Natural Gas market would know that a trend change can seemingly happen at a moment's notice -- especially as the calendar turns, and we move towards the beginning of the Atlantic hurricane season. The most recent Commitment of Traders report shows non-commercial traders (large speculators such as hedge and commodity funds), decreasing their net-short position by over 11,000 contracts for the week ending May 18th, as traders closed out positions in a "flight to liquidity", as concerns over the European debt crisis continued to mount. The large spec net-short position still totals over 95,000 contracts, and could be a catalyst for a large short-covering rally should we see any serious disruptions in the gas production areas of the Gulf of Mexico. Although the peak hurricane month of September is still a way off, the possibility of any weather-related disruption should always be in the back of traders' minds.
Trading Ideas
As veteran traders of Natural Gas options know, option premiums in the late summer and early fall time periods can be relatively "expensive", making outright purchases cost prohibitive for many traders. Short option traders may be tempted by the rich premiums these options normally command, but fear the potential of a sharp rise in volatility should a weather event disrupt Gas production in the Gulf. Traders who believe that Natural Gas prices will remain relatively steady going into the fall but who wish to potentially profit if volatility moves sharply higher may wish to explore a combination trade of selling an at the money straddle and using some of the premium received to buy multiple out of the money call options in Natural Gas options. An example of this strategy would be selling the October natural gas 4.30 straddle and buying twice as many October natural gas 6.00 calls. With October Natural Gas trading at 4.295 as of this writing, this combination (selling 1 straddle and buying 2 otm calls) was trading for around a 0.850 credit, or about $8,500, not including commissions. The trade would be profitable if October natural gas was trading below 5.150 and above 3.450, or above 6.850 at option expiration in September. The trade would not be profitable at expiration if October natural gas was trading below 3.450, or above 5.150 and below 6.850.
Technicals
Looking at the daily chart for July Natural Gas, we notice the choppy price action that has occurred since the beginning of April, as both bulls and bears battle it out to gain control. Currently, bears have the upper hand, as prices have fallen below the 20-day moving average. The 14-day RSI has also turned lower, with a current reading of 40.47. However, since the beginning of April, there has only been one successful attempt to move prices below psychological support at 4.000, and that move was soundly rejected and sparked an over 50-cent rally, as weak shorts ran for the exits. The May 6th lows of 3.971 remain major support for July Natural Gas, with resistance found at the 20-day moving average, currently near the 4.250 area.
Mike Zarembski, Senior Commodity Analyst
