We usually associate moves up in the Natural Gas Futures (/NG) with cold spells during the winter. Increased demand for heat leads to draws on supplies. Natural Gas is increasingly used to produce electricity and so the Summer months can see large moves driven by warm and humid weather. The /NG rose to a 10-month high this week on speculation of high demand. Front-month prices have gained 41% since the June expiration. The June month contract expired at $1.963/mmBtu, while July (active) is now trading at $2.674/mmBtu. How can we best take advantage of this? Our Futures expert, Pete Mulmat joins the guys to explain things, provide a possible trade idea and also a version of the trade that takes advantage of Theta (time decay) to improve cost basis.
Contango, in which the back month Futures trade for more than the front month Futures is the norm of /NG. When demand is high in the Summer the Futures can go into backwardation in which the front months are higher. This typically reverses in the Fall as the weather cools and demand lessens before picking up during the heating season. This summer we have seen almost all of the contango taken out of the Futures curve as the underlying market trades at higher levels. Given the dramatic flattening of the Nat. Gas “Curve”, traders may look to sell a Futures Calendar Spread, betting that the contango will widen from extremes. Pete cautioned that unlike an options Calendar Spread in which selling the spread means selling the back month and buying the front month the reverse is true in spreads of Futures contracts. Selling these spreads means selling the front month.
Pete then laid out his trade idea. It was selling the spread, specifically, shorting the August Futures (/NGQ6) and buying the September Futures (/NGU6). The minimum margin for this trade results in a buying power reduction of just $242 but because spreads have moved a lot lately some firms may require more. The August price was $2.893 and the September price was $2.884 placing the spread price at $0.009. Pete then suggested a way to use options to take advantage of Theta and improve the cost basis by adding what is similar to our common 1 Standard Deviation Strangle. His short put and short call both had the classic 16 Delta put the short put was in the August Futures options and the short call was for the September contract.
Watch this segment of Closing the Gap Futures Edition with Tom Sosnoff, Tony Battista and our in house Futures expert Pete Mulmat for a look into Natural Gas Futures and a possible trade idea.
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