Record Supplies Have Not Deterred Natural Gas Bulls

Fundamentals

The old saying “every dog has its day” could certainly apply to the Natural Gas futures market as the December futures contract has risen to highs not seen since June, despite a record amount of Gas in storage. It is still too early to tell to what extent the recent rally may be due to speculative short-covering. The most recent Commitment of Traders report shows large non-commercial traders were holding a net-short position of 64,050 contracts as of October 13th. This was a decline of 1,902 contracts for the week and does not take into account the activity that occurred during the nearly 0.750 point rally since the report was released. Also adding a bit of bullish fuel to the recent rally are predictions that a weak El Nino weather pattern may result in a colder than normal winter. If true, it may cause utilities Gas usage for heating demand to increase, helping to cut into the current burdensome supplies. Traders are also beginning to anticipate an uptick in industrial demand now that there are signs that the worst of the recession is behind us and an improvement in industrial production may not be far off. However, until we start to see fresh buying entering the market, any major rally attempts could be met with eager sellers — especially with futures trading above cash prices. Traders should monitor government data to gauge the extent of any economic recovery, as Natural Gas futures have been acting as a barometer to economic conditions here in the U.S.

Trading Ideas

Natural Gas options have always intrigued both option buyers and sellers, as the potential for large price moves gives encouragement to option buyers, and the rather steep “premium” that Natural Gas options tend to command make it a tempting play for short option sellers. Given the conflicting fundamentals in the Natural Gas market, some traders may wish to explore positions that involve both buying and selling options on Natural Gas futures. For traders who may believe that the record supplies will eventually cause a sell-off in the Natural Gas market, exploring bear debit put spreads may, perhaps, be in order. An example of this trade would be buying the December 5.80 put and selling a December 5.30 put. With December Natural Gas trading at 5.896 as of this writing, the spread could be purchased for about 0.200, or $2000 per spread exclusive of commissions. The premium paid is the maximum risk on the trade, with a potential profit of $5000 per spread minus the premium paid should December Natural Gas be trading below 5.300 at expiration in November.

Technicals

Looking at the daily chart for December Natural Gas, we notice prices broke above the highs of the month-long consolidation pattern at the 5.300 level. This now sets-up a test of psychological resistance at the 6.000 level. Above 6.000, we see chart resistance at the June 16th high at 6.170. Despite moving to nearly 4-month highs, the 14-day RSI has not made a new high for the move, and may be signaling a potential bearish divergence. Support for the December futures is seen at last week’s lows of 5.280, with major support at 5.200.

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