Weekly options are valuable tools that can help navigate volatility in the natural gas market. Traders are increasingly utilizing these short-tenor options to insulate their portfolios from weather surprises. In the natural gas market, prices are generally more volatile compared to other energy commodities due to the inelasticity of demand and supply. Weekly options are granular, allowing market participants to tailor trading strategies to maneuver sudden changes in weather conditions and storage levels, which can precipitate large price movements. This article illustrates examples of hedging applications of Natural Gas Weekly options.
The unpredictability of the impact of severe weather can present a challenge for traders especially during weather events such as a heat wave, cold snap or hurricane. Fundamentally, weather is the primary factor that impacts natural gas prices in the short run on both the demand and supply sides. Temperatures drive the heating demand in winter and cooling demand (air conditioning) in the summer, whereas hurricanes or storms can cause shut-ins and supply shocks.
Chart: Weather events heightened natural gas volatility
Weekly storage plays an important role in balancing demand and supply. Inventories tend to build up during the injection season (April-October) and ebb during withdrawals from November to March. Essentially, any sudden shift in weather conditions could lead to unexpected changes in storage levels, which could subsequently exert pressure on prices amid increasing uncertainty about future supply.
Natural Gas Weekly options have a contract size of 10,000 MMBtu. The Weekly options expire on the corresponding day of the contract week. For example, a Henry Hub Natural Gas Weekly Friday option terminates on the Friday of the contract week. The short duration provides more flexibility for traders to adjust their portfolios more frequently in response to sudden market events such as unexpected changes in weather conditions or storage levels. This adaptability makes these types of options cost effective and a precise tool in both risk management and executing tactical trading strategies to capitalize on short-term price fluctuations.
1. End-user Hedging Heat Wave
A natural gas end user is concerned about the potential price spike in the summer as cooling demand increases. The trader wants to hedge a directional move of natural gas prices due forecasts for a heat wave in two weeks.
Strategy: Long Weekly Natural Gas call option
Current Henry Hub Natural Gas price: $2.9 per MMBtu
Strike: $3.00 per MMBtu
Premium: $0.05 per MMBtu (reflecting higher implied volatility due to the anticipated event)
Premium paid: $0.05 x 10 contracts = $0.5 per MMBtu
Contract size: 10,000 MMBtu
Total premium paid= $500
After the option expires:
New Henry Hub futures price: $3.1
Intrinsic value of call option: Max ($3.1-$3),0) x 10 = $0.1 MMBtu
P/L= $1000-$500 = $500
2. End-user Hedging Hurricane
During the hurricane season, a natural gas end user is concerned about the potential price spike as a result of supply disruption and shut-ins. The trader wants to hedge a directional move of natural gas prices due to any potential supply shock. The trader can use a long collar (risk reversal) strategy to hedge against price increase by buying a weekly call option with a higher strike and simultaneously selling a weekly put option with a lower strike. This type of strategy allows to mitigate against a price spike and use the premium from shorting the put option to reduce the hedging cost .
Strategy : Long Weekly Natural Gas collar
§ Long call option with a strike of $3.00
§ Short put option with a strike of $2.80
Current Henry Hub Natural Gas price: $2.9 per MMBtu
Call strike: $3.00 per MMBtu
Put strike: $2.8 per MMBtu
Call option premium: $0.05 per MMBtu (reflecting higher implied volatility due to the anticipated event)
Put option premium: $0.04 per MMBtu
Premium paid: $0.05 x 10 contracts x 10,000 MMBtu = $500
Premium received from put: $0.04 x 10 contracts x 10,000 MMBtu = $400
Net cost = $400 – $500 =$100
After the option expires:
New Henry Hub Futures price: $3.1
Intrinsic value of call option: Max ($3.1-$3),0) x 10 contracts X 10,000 MMBtu = $1,000 MMBtu
Intrinsic value of put option= Max (0,$2.8-$3.1) expires worthless
P/L= $1000-$100 = $900
1. Producer Hedging Weekly Storage Report
A natural gas producer wants to hedge against price falling in response to the release of the upcoming weekly storage report. The trader can use a bear put spread, which is simultaneously buying weekly put options with higher strike put option and selling lower strike put option. This strategy is cost effective for downside protection since the premium received from selling the put helps offset the cost of buying the put option.
Strategy: Long bear weekly natural gas put spread
§ Long put option with a strike of $3.10
§ Short put option with a strike of $2.90
Current Henry Hub Natural Gas price: $3.1 per MMBtu
Cost for long put $3.1 strike: $0.05 per MMBtu
Premium for short put $2.9 strike: $0.02 per MMBtu
Contract size: 10,000 MMBtu
Net premium paid: $0.03 per MMBtu X 10,000 MMBtu= $300
After the option expires:
New Henry Hub futures price: $2.9
Intrinsic value of $3.10 put option= Max ($3.1-$2.9,0) X 10,000 MMBtu= $2,000
Intrinsic value of $2.90 put option= Max ($2.9-$2.9,0) expires worthless
P/L=$2000-$300=$1700
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
