Combining Directional Trade and Volatility Play Strategy Using Natural Gas Weekly Options
Natural Gas Weekly options are designed to assist traders in navigating the high volatility in natural gas markets. These short-tenor options are versatile and can be utilized to execute various strategies, including directional trades, volatility plays and income generation. Based on customer demand for a standardized short-term Natural Gas option, a new set of expiration dates have been recently listed covering every day of the trading week. Below are two use cases to illustrate how Natural Gas Weekly options can be used by traders to hedge under different scenarios.
A hedge fund portfolio manager has an existing long position in the front month Henry Hub futures. He is bullish on natural gas prices due to a forecasted severe cold front that can significantly increase the heating demand in major consumption markets. The trader wants to hedge against any weather forecast revision over the weekend (scenario 1) or storage report surprises (scenario 2) that may negatively impact his long directional position. He is interested in mitigating downside risk while maintaining his thesis on upside exposure Therefore, the fund manager can combine a bear put spread Weekly option to hedge against a price decline in a cost-effective way and also sell an out-of-money weekly call option to further reduce the cost.
Strategy: Combining long bear put spread and short OTM call
Scenario 1: Background
On Friday: to protect his position against a downside move in natural gas prices over the weekend, the trader buys five $0.20-wide weekly Monday Natural Gas put spreads. To offset the upfront premium, he sells an out-of-the money Monday Weekly Natural Gas call option with a strike price of $4.10 for $0.04.
- Existing long position of five front month Henry Hub Natural Gas (NG) futures.
- Buy five bear Monday Weekly Natural Gas put spread.
- Long five Monday Weekly Natural Gas put option with a strike of $3.75 per MMBtu.
- Short five Monday Weekly Natural Gas put option with a strike of $3.55 per MMBtu.
Current Henry Hub Natural Gas futures price: $3.75 per MMBtu
Cost for long put $3.75 strike: $0.12 per MMBtu
Premium for short put $3.55 strike: $0.08 per MMBtu
Contract size: 10,000 MMBtu
Net premium paid: $0.04 per MMBtu
- Sell five Monday call Weekly Natural Gas options with a strike of $4.10 per MMBtu.
Premium for received for selling five Monday calls with $4.1 strike: $0.02 per MMBtu x 10,000 x 5 contracts = +$1,000
Total premium paid for downside protection = (put spread cost-premium received) x contract size x number of contracts
= ($0.04-$0.02) x 10,000 MMBtu x 5 contracts
= -$1,000
On Monday: the cold front that the trader forecasted does not materialize and Natural Gas futures prices open on Monday $0.20 lower than Friday’s close.
New Henry Hub futures price: $3.55 per MMBtu
Loss (futures ) = ( $3.75-$3.55) = -$10,000
Intrinsic value of $3.75 put option = max ($3.75-$3.55,0) x 10,000 MMBtu x 5 contracts = $10,000
Intrinsic value of $3.55 put option = max ($3.55-$3.55,0) expires worthless
A short call expires worthless.
P/L= futures loss + spread gain + premium -$10,000 + $10,000 - $1000 = $0
The trader was able to hedge his portfolio over the weekend and protect his portfolio while maintaining his bullish position
Scenario 2: Background
On Tuesday: a bullish trader wants to protect his position against a downside move in natural gas prices due to lower storage withdrawal than the consensus forecast. He buys five $0.20 wide weekly Thursday Natural Gas put spreads, precisely hedging his portfolio for when the U.S. Energy Information Administration (EIA) releases storage numbers on Thursdays. To offset the upfront premium, he sells an out-of-the money Thursday Weekly Natural Gas call option with a strike price of $4.10 for $0.04.
- Existing long five front month Henry Hub Natural Gas futures.
- Five long bear Monday Weekly Natural Gas put spread.
- Five long Monday Weekly Natural Gas put option with a strike of $3.75 per MMBtu.
- Five short Monday Weekly Natural Gas put option with a strike of $3.55 per MMBtu.
Current Henry Hub Natural Gas futures price: $3.75 per MMBtu
Cost for long put $3.7 strike: $0.12 per MMBtu
Premium for short put $3.5 strike: $0.8 per MMBtu
Contract size: 10,000 MMBtu
Net premium paid: $0.04 per MMBtu
- Sell five Monday call Weekly Natural Gas options with a strike of $4.10 per MMBtu.
Premium received for selling five Monday calls with $4.1 strike: $0.02 per MMBtu x 10,000 x 5 contracts = +$1,000.
Total premium paid = (put spread cost-premium received) x contract size x number of contracts.
= ($0.04-$0.02) x 10,000 MMBtu x 5 contracts
= -$1,000
On Thursday: natural gas storage comes off its five-year highs and sends natural gas prices $0.35 higher.
New Henry Hub futures price: $4.1 per MMBtu
Gain (futures ) = ( $4.1-$3.75) x 10,000 MMBtu x 5 Contracts = $17,500
Intrinsic value of $3.75 put option = max ($3.75-$4.1,0) x 10,000 MMBtu x5 contracts = worthless
Intrinsic value of $3.55 put option = max ($3.55-$4.1,0) expires worthless
A short call is worthless.
P/L= futures gain + premium = $17,500 - $1000 = $16,500
This strategy allows the trader to hedge downside protection while capitalizing on upside exposure in a cost-effective way.
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.
