Good example when to sell options. This was posted back in November and the market has moved up and down giving the possibility to put on such a strategy as I Mentioned a few days ago, if you had you would be making money now.. A good re read. There is risk in trading futures and options.
Comodities Roundup: Natural Gas
James Cordier & Michael Gross, Optionsellers.com
November 1, 2010
Winter is approaching and Natural Gas prices have been in a vicious downtrend for 4 months now. Prices have sunk below $4.00 per mbtu, a level that the bull pundits are screaming is a “value.”
Should be a slam dunk buy, right? After all, isn’t winter peak demand season for natural gas? Doesn’t the current Natural Gas chart look like a classic “bottom?”
The answer is “yes” on both accounts. But we at Liberty Trading still believe that selling natural gas calls in late 2010 will be one of the most fundamentally sound plays on the board.
Short term Trading vs. Option Selling
Natural gas prices have been beat up for so long, it is only “natural” to expect a correction at some point. The current chart’s classic reversal formation coupled with the first reports of cold weather could easily bring some value hunters into this market over the next few weeks. Short term futures traders that want to try their hands at picking direction take note: This market is probably as good a dice roll as any.
I myself [James Cordier] don’t like rolling dice. That’s why I only sell options. It allows me to play longer term fundamentals without overly subjecting my positions to short term market whims.
And the longer term fundamentals are why this market has sunk, and why it will probably continue to remain near or around current price levels for some time.
Burdensome Supplies Will Hinder but not Prevent Rallies
Chart 1: The latest EIA report shows Natural Gas Inventory levels at record highs for this time of year. (Chart courtesy Hightower Research)
Natural Gas could very well be in for a rally in the short term. Liberty Trading's opinion is that any such rally will be limited in nature and will present opportunities for selling deep out of the money calls. There are 3 primary reasons for this viewpoint.
Newly discovered natural gas fields in areas such as Texas, North Dakota and Pennsylvania have begun contributing to supply channels this year, boosting pre-winter inventories to 2.764 billion cubic feet – near record levels for this time of year.
Winter is indeed peak demand season. Traditionally, however, prices have tended to rally into winter and then fade once the cold weather arrives in earnest. This is because anxiety runs highest during the accumulation phase of the supply cycle. Traders tend to buy on any concerns that supplies will not be adequate enough to meet winter demand (this fear is often accentuated by hurricane threats). Yet, once supplies are deemed adequate to meet winter demand needs, the anxiety eases, and thus, prices often do as well. There were no real hurricane threats to production areas this year and inventory accumulation ran far ahead of schedule all season. As a result, prices did not rally this fall. Now we reach the point in the year where prices have historically tended to weaken. The only reason natural gas prices have to rally at all would seem to be technical. And technical rallies that lack supporting fundamentals tend to be short lived.
Bulls have made a major point as to the “historically low” levels that natural gas now finds itself. But prices are at these levels for a reason. “Historically low” is a relative term. January 2002 saw Natural Gas prices fall to $1.86 per mbtu – less than half of today’s price level. This happened, mind you, in the heart of winter at a time when supplies were lower than they are today. Prices may be “historically low.” But they can go lower.
Summary and Trading Suggestion
This week’s action in Natural Gas prices suggest that a long overdue rally may finally be in the works. We advise call sellers to be patient as volatility remains relatively low in natural gas options at this time. A price rally back to the $4.60 level basis the March contract would be a good place to start taking in call premium in natural gas. Look for strikes at levels at least double the price of the underlying contract.
Volatility created by such a rally should make this possible. Clear cut fundamentals should make it a good investment.
Chart 2: March 2011 Natural Gas
Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.
James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
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