This month we will be looking at the MRCI March 16 vs Feb 16 Natural Gas bear futures spread. According to MRCI’s Spread Outlook report “The heating season begins November. As temperatures get progressively colder, distributors sell more gas into the retail market. January is historically the coldest month of the year, with supply typically flooding the market.” From our perspective, the interesting thing to note here is Natural Gas in the futures market is a commercial market, not a retail market. By the end of November a lot of energy distributors have already stocked up on Natural Gas to provide heating for their retail customers. In my opinion, what MRCI is saying is the commercial demand starts to wane in the Natural Gas futures market while they turn their attention to distribution on the retail market.
TRADE: Buy March 2016 Natural Gas and sell February 2016 Natural Gas on 11/24 and exit 1/17. Suggested risk is $1487 stop on close. Margin is $224 per spread. Average profit on winning trades the past 15 years is $1413.85. Worst drawdown in 15 years is $6200 in 2001.
MRCI Hypothetical P&L Table
The MRCI Hypothetical P&L Table below shows this trade worked out 13 out of the past 15 years when entering at the settlement close on 11/24 and exiting at the settlement close on 1/17. In the past 13 years when the trade did work out, the P&L was less than $500 four times, between $500 and $1000 four times, and over $1000 five times. It is important to note Natural Gas is at much lower price now than it was back in the 2001 to 2008 period. Before the natural gas shale revolution, Natural Gas prices were trading between $5 to $13 per million BTU. For the past year we have been trading in the $2 and $3 ranges. This is important because if the flat priced futures are lower, more likely than not the spread prices will be lower. That is why when you look at the MRCI Hypothetical P&L table for the past 15 years, the Best Equity and Worst Equity amounts are much bigger prior to 2008. Note there were drawdowns in 2010 of $1100, 2004 of $4550, and 2010 for $6200. I think this year we see P&L fluctuations more like those seen in 2009 and forward due to the low price of Natural Gas
15 Year Seasonal Trend Chart
The fifteen year seasonal trend chart below shows this year’s price spread (black line) trading relatively well with the 15 year average (blue line). I like to see that because it suggests the normal seasonal forces may be at work this year (could also be a coincidence).
15 Year Monthly Spread Price Chart
The monthly chart below shows where this spread has been trading since 2002. Since 2010 this spread has been in a tighter range, between -0.20 and +0.10, as compared to years before 2010. I think we are in a tighter range again this year with Natural Gas prices in the $2 and $3 ranges.
Final Thoughts
Natural Gas fundamentally is in an oversupplied market according to the US Energy Information Administration (EIA) and prices have been weak for a majority of 2014. When this spread goes against the seasonal trend it is usually due to unseasonably cold temperatures that cause more demand than expected. One example that comes to mind is the polar vortex the US experienced two years ago. Most weather forecasters are expecting mild weather for the next few weeks. Mild weather combined with a large supply of Natural Gas should work well for this seasonal bear spread in theory.
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Risk Disclosure
EXAMPLES OF HISTORIC PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR ARE LIKELY TO OCCUR.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.
ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADE PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF THE HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.
STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.
EXAMPLES OF SEASONAL PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR LIKELY TO OCCUR.
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