What Should Natural Gas Traders Learn From the Oil Market?

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April 28, 2020 9:44am NYSE:UNG

NYSE:UNG | News, Ratings, and Charts


  • Natural gas moves towards $2 per MMBtu but failed
  • The seasonal rally breaks the bearish pattern
  • Crude oil could one day be a harbinger for the natural gas futures market and is a lesson for option sellers


I have been trading commodities for almost four decades. In markets, one is never too old or too experienced to learn. One of my first bosses in the trading business told me always to expect the unexpected and never to say never.

The nearby price of crude oil futures not only traded in negative territory last week, but the price also dropped to a low of $40.32 per barrel below zero on April 20. On the same day, the other energy commodity, natural gas, moved higher and broke a bearish technical pattern that had been in place since November 2019. While natural gas and crude oil moved in opposite directions at the beginning of last week, the oil market taught natural gas market participants two critical lessons that traders and investors should not ignore.

The United States Natural Gas Fund (UNG) and the triple leveraged UGAZ and DGAZ ETN products replicate the price action in the natural gas futures market on an unleveraged and leveraged basis.

Natural gas moved towards $2 per MMBtu but failed

It was ironic that on the day that May crude oil futures fell into negative territory for the first time, May natural gas rallied.

(Source: CQG)

As the daily chart of the expiring May futures contract in natural gas highlights, the price of the energy commodity rallied to its highest price since mid-March on April 20 when it moved to the $1.97 per MMBtu level. While the price of May futures fell back to just below the $1.80 level late last week, price momentum remained above neutral territory with relative strength at a neutral reading. Wide intraday trading ranges kept the daily historical volatility measure at around 86.5%. Meanwhile, the total number of open long and short positions at 1.211 million contracts on April 23 was close to the lowest level of 2020. The low occurred on April 8 when the price reached a lower high of $1.918. The price put in a higher high last week but failed and fell below the $1.80 level on Friday, April 24.

The seasonal rally breaks the bearish pattern

 Natural gas futures were rolling from May to June at the end of last week, but the market ended a bearish pattern that had been in place for six months when the price traded to a high of $1.974 per MMBtu.

(Source: CQG)

The weekly chart shows that the energy commodity did nothing but make lower highs since early November when it reached a peak of $2.905 on its way to $1.519 in late March, the lowest price in twenty-five years. The last lower high came during the week of April 6 at $1.918. Last week, the price traded to a high of $1.974, which ended the bearish pattern. On the weekly chart, price momentum and relative strength metrics remain below neutral readings but were trending higher.

Natural gas tends to make lows at the end of the peak season and rally in the spring, which could account for last week’s price action. However, weekly historical volatility at the 53.3% level was appreciably higher than over the past three years in April when it stood at between the 20%-30% level. The higher level of price variance is a function of overall conditions in markets across all asset classes in 2020.

Crude oil could one day be a harbinger for the natural gas futures market and is a lesson for option sellers

While natural gas ignored the action in crude oil last week, market participants should learn a lesson from the oil market. The delivery point for NYMEX oil futures is in Cushing, Oklahoma. The lack of storage capacity sent the price of crude oil to under negative $40 per barrel as the expiration of the May contract approached. Those with long positions found themselves selling at any price to close risk positions. The delivery point for NYMEX natural gas is in Erath, Louisiana, and a similar situation in the future could send the price of natural gas below zero. Crude oil futures had never traded below the $9.75 level before last week.

(Source: CQG)

The quarterly chart shows that the standing low in natural gas futures is at the 1992 bottom of $1.02 per MMBtu. Oil taught us that natural gas could fell to levels below the 1992 low and into negative territory if storage capacity cannot accommodate those looking to take delivery and hold a long physical position for the future.

The other lesson was that the risk on a short put position is not limited to zero. Put options tend to trade at lower implied volatility levels than equidistant call options as market participants assess the risk of the upside at infinity and the downside at zero. However, oil reminded natural gas market participants that there is no implied put at zero in the market, and the price could fall into negative territory.

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The United States Natural Gas Fund L.P. (UNG) rose $0.48 (+3.62%) in premarket trading Tuesday. Year-to-date, UNG has declined -40.91%, versus a 9.60% rise in the benchmark S&P 500 index during the same period.

UNG currently has an ETF Daily News SMART Grade of F (Strong Sell), and is ranked #66 of 109 ETFs in the Commodity ETFs category.

About the Author: Andrew Hecht

andrew-hechtAndrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.

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