Excell with Options: Is Natural Gas about to break out?
Executive summary
After observing lower than average Natural Gas futures prices and assessing the possible state of supply and demand for it in the coming years, Rich uses a weekly options spread to take a bullish stance.
Image 1: Seasonality of natural gas futures prices over the last 10 years
There are some prices in the market that have even the casual observer, if not the market veterans, scratching their heads and asking questions. For some, that may mean a rise in the stock market. For others, that may mean depressed natural gas prices. I know last month when I was a guest on the “Options Insider” podcast with Mark Longo, the audience was asking about natural gas prices and whether I thought they had the chance to breakout any time soon. For an economy that has held up better than many expected and a commodity that is levered to the economy, the level of futures was leading to questions.
This should not be surprising. When I look at the path of futures prices this year relative to the path taken over the last 10 years, I have never seen more consistently lower prices. The light blue line in the graph below is this year. The darker blue line is the average over the last 10 years. Not only has the path of prices been lower than average, but the path has also been below every year of the last 10 years for the entire year.
Image 2: Natural gas futures prices curve analysis
We can see this not just in the front month futures but across the entire futures curve. A simple analysis of the nat gas commodity futures curve shows that while we see the typically seasonality throughout the year, the so-called should seasons of March-April and September-October, the entire futures curve is much lower than where it was a year ago. This suggests to me that we are seeing the same cyclicality we might normally expect, but there may be something more secular at work in terms of supply and demand. The cyclicality that is normally due to expected usage surrounding the weather is still quite evident. In fact, the spikes are expected to be slightly larger than historically, perhaps due to the low current prices. Even as we look at futures prices 10 years ahead, they are still much lower than average.
Image 3: Weekly Ichimoku cloud chart for generic first nat gas futures
We see this as well in the long-term technical chart of the generic first contract for nat gas. At $2.75, prices are much closer to the 20-year lows of $1.75 than at the 20-year average of $4.65. That said, a base appears to have been formed around $2 with that level having been tested several times this year and holding. While prices are still below various moving averages and therefore facing some resistance on the upside, there may be a sense that the reward to risk could favor the upside with a base having been built.