Seasonal Play: Natural Gas

May 13, 2018 03:00 PM
Trading Technique

Natural gas is a tough market to call in the short term. Weather forecasts can bring public speculators to the market in mass, causing wild daily fluctuations, especially during the winter months. This makes pure gas futures trades risky. But if you’re an option trader, this is a fantastic market to ply your trade. 

Why? Because the public participation and daily swings provide ridiculously deep out-of-the-money option strikes at healthy premiums. And while speculators may drive the daily price whims of this market, it offers some surprisingly reliable demand-led cycles that drive longer-term price direction. 

Knowing these cycles can give you a tremendous advantage as an option seller while allowing you to stay above the fray of daily market fits and starts. 

Last month, this magazine highlighted how a contributor had warned readers six months prior of the growing trend of shorting equity volatility in a period of historic low volatility. The gas market does not have that problem. 

As natural gas has seen just such a speculator-led bout of volatility, prices now appear out of synch with their core fundamentals and may be in an ideal position to benefit from a strong historical price tendency. This could provide a lucrative play for option sellers this spring. But first, let’s understand this seasonal price tendency and how it is setting up this year.

Seasonal Natural Gas Demand Cycles 

Natural gas, like many commodities, has certain times of the year when demand is higher or lower. In gas, these cycles are based on the weather. Winter is the peak time for natural gas usage due to heating needs. But natural gas also has a secondary demand season. In summertime, electricity demand surges as U.S. consumers power up air conditioners. As many electric plants in the United States are now powered by natural gas, demand for gas surges. 

Because traders understand and study these tendencies, price often precedes consumption. This is because commodity futures values are more reflective of prices at the wholesale level, not at the retail level. Thus, natural gas prices have historically tended to peak in the fall and again in early summer, well ahead of the peak retail demand periods. 

In the winter months, while retail demand is at a peak, wholesale demand is often slack. This is because distributors have typically already accumulated enough supply to meet winter demand needs. Thus, it is not uncommon for natural gas prices to show weakness through winter months. This tendency, of course, can be interrupted by exuberant speculators betting on weather, as we’ve seen in Q1 2018. 

By the end of winter, however, distributors’ supply levels are often depleted. Thus, they begin aggressively rebuilding inventories to both meet summer electricity needs as well as next year’s heating needs. As a result, even though the springtime in the United States can be a period of low natural gas usage, it can bring a surge in natural gas demand at the wholesale level. This is why, on average, springtime can be a time of firming natural gas prices (see “Gas seasonals,” right). 

Bears Overplayed Their Hand

While seasonal average charts can be of tremendous benefit to option writers, you must remember that these are just average tendencies. Markets can and do vary widely on price patterns in any given year. This is often driven by the weather speculators we discussed earlier. 

Natural gas prices saw a counter seasonal surge from late December through early February. This was based largely on a series of highly publicized winter storms in the Northeast during that period. Large trend following strategies helped drive the rally. 

A slew of media coverage and the newly created tradition of “naming” winter storms brought out the public to speculate on natural gas prices. 

However, when the storms passed and weather forecasts began to mitigate in February, the market found itself perilously overbought. Funds and small speculators liquidated aggressively. This brought the market right back down to where it should be this time of year (see “Gas goes rogue,” below).


Or Should It?  

Weather may look benign, but the supply situation in natural gas does not appear to be bearish. In fact, headed into peak demand season in natural gas, the market could now actually be underpriced. The liquidating bears could have overshot. 

End of Winter Supplies Down 

Speculators and funds unwinding long positions are most likely missing the bigger picture. Natural gas was overbought in February for sure. But current inventory levels could support a seasonal rally in March or April. 

The latest Energy Information Administration’s (EIA) Natural Gas Storage Report (released Feb. 9) shows 2018 inventory levels at 1,884 billion cubic feet (bcf), down 23% from the same time last year, and down 19% from the five-year average (see “Depleted stocks,” below). Natural gas storage levels have declined by an additional 700 bcf in the month following the report. 

While supplies have dwindled this winter, the EIA projected record U.S. demand of 27,633 bcf for natural gas in 2018. This is due not only to increasing industrial production but also to older coal fired electrical generating facilities being replaced by modern natural gas powered plants. 

While we are not in the business of calling highs or lows in the market, the natural gas market now appears to be in prime position to take advantage of a seasonal tendency for higher prices. In addition, fundamentals appear supportive for price firming into the spring and summer months of 2018. Supplies are below five-year averages and the demand outlook is strong.

Does that mean we bet prices will move higher? Of course not. Option sellers don’t bet. All factors appear supportive through the spring. That doesn’t mean prices can’t move lower. That is why— particularly in the natural gas markets—we don’t try to predict such things. But we don’t have to. We simply pick a point well below current prices where we believe the market most likely won’t breach, and then we get paid to wait. 

In this case, that means selling puts at nicely inflated premiums. We’ll be selling a series of strikes we feel won’t be challenged. Consider selling the September 2.25 puts for premiums of $500 or higher (see “Value play,” below). The options expire Aug. 28. The margin requirement is approximately $1,150 per option. 

With an August expiration, these options should show significant time decay with any type of natural gas price firming into the spring. 

The weather players have had their day in January. They have set a nice table for fundamentally based option sellers this spring. Put premiums are available at a solid price going into the higher demand cooling season, leaving put sellers with a valuable seat at the table.   

About the Author

James Cordier is the founder of, an investment firm specializing in writing commodities options for high net-worth investors. He is the author of The Complete Guide to Option Selling 3rd Edition (McGraw-Hill 2014).