There is a huge oversupply of natural gas right now. Almost every article I read talks about how the near future for natural gas prices looks grim, and no-one expects it to go over $4 anytime soon unless there is a major hurricane (hurricane season is just starting) or a really cold winter.
Here are some recent articles to read:
It's all over the news in Alberta too. The alberta natural gas price has been forecast to even fall under $1 in the coming weeks:
(Note: prices in Canada are quoted in different units, but the conversion factor is close to 1.1, I believe).
So why I'm I interested in this? Well, the NYMEX December contract (expiring end of November) is currently trading above $5 right now. Every 1 dollar move in natural gas is a $10,000 change in value for a single contract (which requires about $10,000$5000 margin).
Now it seems to me that the December contract is very optimistically priced. If the Natural Gas spot price were to remain at its current price for the next month, the December contract would likely drop to around $4.20, judging by November's current price. This would be an $8000 gain / 80%160% gain in one month if you had sold the December contract (like shorting a stock).
It seems like easy money, however:
- the price is so low, it could easily rebound a bit. A $1 move up means a $10,000 loss. Natural Gas has many times historically moved $2 or more within a single month.
- the market is usually smarter than you. If it's so obvious that prices are going to stay low, then why is the December price currently still over $5? There must be something the big players know that I don't.
I'll have to play it careful. For one, I wouldn't actually buy the regular contract - it's too big and I could lose all my money. There is a mini natural gas contract that is 1/4 the size ($2500 for a $1 move). I'd only sell a couple of those. Secondly, I'll probably hedge my trade by buying a nearer term contract, in case prices do go up. I'll have to figure out mathematically what makes the most sense.
I worry that I won't get my account setup soon enough though, and by then prices will have dropped further, making it too risky to sell natural gas at such low prices. I wanted to get in at the beginning of August, when I first started reading up on all this dire news on natural gas. At that time, the December contract was above 5.50. Already I'd be up about $5000 on 1 normal-sized contract.
Oh well, if natural gas doesn't work out, I'll probably buy into gold on dips and sell on short rises. A $10 move in gold is a $1000 gain on one contract (about $5000 margin). I feel way more familiar with gold anyway.
10 comments:
So, selling the Dec contract is like buying a PUT, right? So can't you just hold until the end? For example, suppose you sold the Dec contract now for $5. NG is at $1. so in 3 months, it would have to rise more than 400% in order for you to realize a loss on your contract, right? At the end of Nov, when the contract settles, you get the difference between $5 and whatever the current price of NG is, right?
Of course, in the meantime, you might get margin called, because tomorrow NG could jump to $4 and the Dec contract would go through the roof to $9 or something, but as long as you held and NG stayed below $5 by the end of Nov, you'd still make money, right? Except with the spike you'd have to post way more margin, and you probably wouldn't want to because you'd be afraid that it could spike way of $5 before end of Nov and you could lose a lot of money.
Another story (on the UNG ETF):
http://seekingalpha.com/article/159042-natural-gas-etf-the-short-term-story
To jonbnews: Yep, exactly. A few points though:
-I wouldn't hold to the end because natural gas is more likely to spike up in the hurricane season starting now and in winter. Also, the farther it drops, the more likely it is to spike just due to speculators jumping in because of the crazy low price. If I can make a good profit in a month, I'd probably get out. Natural gas can easily rise 400% to $5. It's probably misleading to use percent here because the price is so low.
-The leverage is so huge in futures, it's often not feasible to "hold on" during a spike in the wrong direction. If the margin requirements are $5,000 per contract, then a spike to $9 in Dec futures would require you to have $20,000. I guess that's not that bad, but if that happened, I would highly doubt the price would come back down to $5. And if it stayed at $9, you'd lose 300% of your original investment, i.e. $15,000, by holding on, unlike with options where you only ever can lose 100%.
You can actually buy options on futures. I should look at that, but the premiums are probably crazy.
BTW, here's where you can see the current contract prices:
http://futures.tradingcharts.com/marketquotes/NG_.html
Or look at any type of quote here:
http://futures.tradingcharts.com/menu.html
Wait, I screwed up in my last comment. I got the margin requirements and the value of the contracts confused. In the futures world, Margin is just like a down payment, but you still have to be able to cover whatever you've lost on top of that.
Basically, my account value has to be $5000 in order to buy/sell 1 contract of natural gas. Say I have exactly $5000 in my account (which would be stupid, because even a penny drop and you'd get a margin call). If natural gas moves $1 against me, that's a $10,000 drop in my account value. So I actually need to supply that full value -- an extra $10,000 -- to meet the margin requirements, i.e. to keep my current account value at or above $5000.
So in my earlier example, if natural gas went to $9, you'd need $40,000 + $5000 = $45,000 in your account to avoid a margin call. This doesn't have to be cash, just the value of all your positions.
If natural gas stayed at $9, you've just lost $40,000 ( ($9 - 5$) * $10,000 ) or 800% of your initial $5000 investment.
This is why you don't "hold on". And this also demonstrates why most people eventually lose all their money when trading futures. $5000 margin doesn't sound like much, but you have to look at the value of what you're controlling. This is why I'll actually be playing the e-mini futures, which are 1/4 the size for natural gas.
One more whoops: I see you're saying the current price wouldn't be $9, but the December price could be if natural gas shot up to $5 or so, and yes, that would come down over time and you'd eventually break even if it stayed at $5. Still though, it's almost impossible to hold on in the meantime unless you have tons of money, and it's not worth the risk.
Well then you're screwed. NatGas is so low right now. If you're just trying to do a short term play with huge margin based on a very short-term move lower in the price, then I think that's way too risky. It's so low, there's much more chance it starts going up and you lose your shirt. I'm not sure how you protect against this. If NatGas goes up 10% the day after you buy the futures, how much do you stand to lose?
The way to play this to make money is that you have to ride out the spikes, I think. Yeah, you needs tons of cash to cover the margin, but you still run a good chance of making money because of the time decay and because the premiums are so high (more than 200% higher than the current spot price). But then you're still screwed because if it does shoot higher than $5, with the leverage you could lose way more money.
Dude, you're totally screwed. I'd just stick to options on an ETN like UNG or something.
One way you can protect it is to buy the near-month contract each month. This will limit your risk but usually will also limit your gains since you lose the premium each month if prices stay the same or drop, which could add up to more than the profit from the far-term contract.
So an example... here are the numbers right now:
Spot price: $2.35
Oct price: $2.70 (20 days to expire)
Dec price: $4.70
I might sell 2 mini Dec and buy 1 mini Oct for a bit of protection. I'm not sure if you get a deal on the margin due to the offsetting nature of these trade. I think you do. So the margin might be around $1500.
Worst case scenario: NG magically skyrockets to $5 in 20 days. Dec contract would be around $8, and Oct contract expires at $5. Here's the change in my account value as of then:
($5 - 2.70)*2500*1 + ($4.70 - $8)*$2500*2 = -$10750. So I'd need around $12250 in my account to ride this out. This sounds bad, but two things:
1) My break-even when Dec expires (end of Nov) would be a NG price of $6.35. Anything lower than that and I'd end up making a profit with this trade. Like you said, if you can ride out the temporary spike, it's an almost guaranteed profit, but you still need a lot to ride out ($12000 is a little more doable than $40,000).
2) This would never happen. I'd never let myself get almost wiped out like this. If prices started going up, I'd buy another near-term contract to prevent any more losses if the price were to keep going up. E.g. As soon as NG went up $1, I'd buy another nearer-term contract (for a total of 2), so that I'm roughly neutral (2 long, 2 short), meaning I've temporarily frozen any change in my account value no matter what natural gas does, whether it keeps skyrocketing or not. Technically I'd lose money due to a bigger premium drop in the near-term contracts than the far-term contracts, but whatever. So anyway, I'd be temporarily down $5000 and I'd be limiting my temporary loss to this. I'd get rid of the nearer term contracts when the rally seems to fizzle out. Assuming the price didn't go up anymore, I'd probably still crack a small profit in the end.
Yeah, the market could drop right at the moment I buy the other offsetting contract, and could keep whipsawing and totally screw me over as I keep buying/selling at the wrong time, but this is highly unlikely.
The more likely scenario is that I could actually make profit from both ends up the trade. If NG goes up to $4 slowly, I'd make a bit from buying the nearest-term contract each month as well as from selling the long-term contract, while lowering my risk compared to just outright selling the far-term contract.
mistake above in point 2: I'd only be down $2500 temporarily, not $5000 (long contract up $1 = +$2500. 2 short contracts up $1 = -$5000. Combined: -2500.)
I dunno. You have to be pretty nimble. What if NG goes up $2 over a long weekend or something? You don't get a chance to buy after it's just gone up $0.50 or $1 or something. Or what if you get distracted at work or on vacation or something. You could totally get screwed.
Well yeah, you have to monitor your trade. Futures contracts typically are tradeable 7 days a week, 23h15m a day, but not on holidays. So you might have to wait max 1 day to trade. Looking through the history, I saw a max 1 day move of $1.50 or so, and a $3 move over 3 days.
Yes I agree it's risky, but not unmanagebly risky. To me, this type of trade is almost identical to selling way out-of-the-money naked call options on a stock, but without requiring nearly as much up-front margin.
E.g. Apple is at $170 right now. You could sell 100 Jan.15 $250 calls for $0.40 each for a $4000 profit. Note: Apple's highest all-time price ever is around $200. Just like with selling our futures contract, the premium gradually declines to zero over time (although you get the initial expected profit up front with the option). Now if Apple were to announce some good news on the weekend, the stock could jump to $190 in one or two days and the calls would go to around $1.20 and you'd imediately be down $8000 ($12000 - $4000 initial profit) before you could take measures to stop any further losses. So a $8000 max risk for a $4000 reward, on a well-managed trade.
With NG futures, selling an e-mini futures contract at $5 and expecting to be able to buy it back at $4 (a $1 move) is an expected return of $2500 for the single e-mini contract. And remember, NG spot price is currently only $2. In the worst-case scenario of NG going up $2 overnight, you'd lose $5000 before you could take measures to stop further losses.
So you're risking about the same: $5000 risk for a $2500 reward.
In both cases it's temporary risk. if Apple stays below $250 before Jan 15, or NG stays below $5 before Nov.27-ish, you could at least break even in the end. However, since you need to manage your risk and offset your trade, you'd probably still lose money in this worst-case scenario.
The difference between the two above scenarios is that naked selling of 100 Apple options, even way out-of-the-money ones, probably requires a ton of margin. I don't know how much, but I'm guessing $20,000 or something. Whereas the NG e-mini contract requires only about $1,250 initially, up to $6,250 at the point when you're down $5000.
And with lower margin requirements, your rate of return on your trade is technically way higher.
With the risk involved, you need to be about 75% sure of being successful on this type of trade. Say 3 out of 4 times are succesful and you make the $2500 ($7500 total), and 1 out of 4 times you hit your max risk and lose $5000. Then you're still up $2500 in the end.
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