Natural gas has been utterly decimated since early July, dropping 60% from its high. There are several good reasons for the decline: a strengthening dollar, new supply and demand expectations, and bursting of a commodities bubble. Volatility is a scary thing, but it is the bread and butter of the savvy option investor. There are several ways to play natural gas that can more than pay for your winter heating bills.
My favorite way to play commodities is by using exchange-traded funds (ETF's); in this case, UNG. Trading futures contracts can be far more lucrative, but comes with a commensurate amount of risk. For the small investor, I recommend sticking to ETF's. They offer representative price movement with far less risk.
Long-term natural gas volatiliy has an average of 45%, whereas short-term (3 month) volatility is currently up to 54%. That information, alone, points to market expectations of more future movement than we've seen in the past. However, taking this a step further and analyzing specific contract implied volatilies for UNG, tells us something slightly more profound: the market expects natural gas to move upward..sharply! Looking at September 2008 puts (strike 30) shows implied volatility of 48%, while the same maturity calls (strike 42) show a crazily high implied volatility of 63%! Markets definitely favor higher natural gas movements in the near term.
We have a few options at this point...
Buying UNG is the simplest way to bet on higher natural gas prices.
Pick up longer term call options for UNG. Buying longer term options gives more time for the bet to work out in your favor, and buying deep in-the-money (ITM) contracts reduces some of the heft time premiums (as a % of investment).
Consider more complicated options strategies, such as ratio spreads, iron condors skewed on the long side, and bull put spreads. These all involve limiting total position exposure by simultaneously selling short and buying long contracts of variable strikes. I'm a fan of credit spreads, in which you are paid up front for opening the position and keep the premium if the asset expires within your desired range.
The only right or wrong when it comes to markets is what works in the end. The only thing I know from my short vantage point is that natural gas has moved a lot in the recent past, more than it has historically. Implied volatilities are high, but coming down on the put side and increasing on the call side. This means market participants expect prices to rise in the future, disrupting a significant two month downward spiral for the commodity. Stick to what you're comfortable with, but consider alternatives in a limited fashion.
About the Author:
If you liked this discussion visit more written by Robert Viglione and his staff at The Freedom Factory. The site is dedicated to political and economic freedom, two powerful concepts which cannot be decoupled.
No comments:
Post a Comment