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Sell Nat Gas Producers and Buy UNG.

scriabinop23's picture




 

An interesting trade idea: Buy puts on the natural gas producers and calls on the natural gas tracker ETF UNG. This is very against any long term investing position I'd normally consider in the natural gas sector, since UNG has cost of carry and contango effects to deal with. But now may present a time window to take the opposite side of "common sense."

 

By the chart above, natural gas appears to have technically put in a bottom. As painful as the 15 or so month gas bear market has been, I have a hard time believing the "recovery" will be a pitiful few days. Of course, this might be a headfake since the fundamentals are still relatively lousy (despite being so well known). The announcement of the UNG ETF expansion alongside with increased transparency in CFTC COT reports have certainly helped the bullish case for natural gas. Regardless, contango is wide enough between the front months that those spreads have room to continue to close in. If they do, the UNG and any natural gas front month tracker will likely do well.

At the same time, the fundamentals of a natural gas producer stock are different, since they are priced off of future earnings of production as well as today's. A producer such as Chesapeake (CHK) is in the mid-28 price range, whereas 2 months ago it was in the 17s. That is a 65% price recovery.

During that same recovery period, a distant natural gas contract such as December 2010 has oscillated minimally in the 6-7 range. The trade here is based off the idea that CHK should be priced to longer term expectations of the natural gas market, not merely the whims of what is happening to today's gas. An earnings stream of 5 years of gas at $2.00 this year and $6.00 the following four years justifies reducing the relevance of the front month's volatility to a producer stock's price.

For context of long dated December 2010 gas (relatively unchanged) versus a producer like CHK (shown above):

Even Chesapeake's 27% move up during the last two weeks was accompanied by much less fireworks in the long dated gas. Clearly, there is multiple expansion and/or economic recovery getting priced into the broad equities market. This is of course affecting Chesapeake and other gas producers, probably explaining the bulk of this move (as opposed to natural gas price).

In the end, the fundamentals reign. If front month gas continues to move exuberantly, UNG (and CHK) will benefit. Entering this long UNG call / long CHK put trade is a limited exposure long natural gas play, one especially valuable in an already generally long equities portfolio. If equities decide to reverse, the portfolio will have some negative coverage in an already extended natural gas sector.

 

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Thu, 09/17/2009 - 16:23 | 72676 Anonymous
Anonymous's picture

Long UNG prior to Halloween is a stupid tax. The producers are going to max out storage. Dead cats aren't even good for violin strings anymore.

Thu, 09/17/2009 - 07:39 | 72135 Crude Oil Trader
Crude Oil Trader's picture

I have never seen a commodity that is near it's lows that just keeps coming. Something is up. Have these guys already seen the Whitehouse memo? It was the Chinese last week, is it the Saudis this week? Like it or not , with all of it's problems, you at least need to have a small position UNG, you can't just sit this one out.

Thu, 09/17/2009 - 06:32 | 72115 Anonymous
Anonymous's picture

Anyone using GAZ instead of UNG or HNU? Comments on premium etc?

Wed, 09/16/2009 - 22:17 | 71915 Anonymous
Anonymous's picture

hahahaha......UNG?

screw that!......three little letters.....HNU

Thu, 09/17/2009 - 05:08 | 72100 slowtwitch
slowtwitch's picture

One little problem with that - it trades on the Toronto exchange.

Once UNG continues issuing new shares consistently like in the past that will take care of the contango problem and trade very close to it's NAV like in the past. If you read the prospectus that's how the fund was originally setup to operate. All was going well until the CFTC had to intervene.

Wed, 09/16/2009 - 11:14 | 71062 Anonymous
Anonymous's picture

Yes BUT how about the stupid index funds that will keep pushing these NG producer equities irrespective of fundamentals !! The dumb money will destroy the smart money thanks to the fed!!!

Wed, 09/16/2009 - 13:12 | 71253 Anonymous
Anonymous's picture

And the people making more money than you... You consider them the dumb money?

Wed, 09/16/2009 - 13:09 | 71249 Anonymous
Anonymous's picture

Let me guess... You consider yourself the smart money?

Wed, 09/16/2009 - 11:11 | 71048 FreddyInBangkok
FreddyInBangkok's picture

it would seem likely this relationship has reached somewhere close to its perigee

http://img33.imageshack.us/img33/2189/1274r.png

 

Wed, 09/16/2009 - 10:54 | 71028 FreddyInBangkok
FreddyInBangkok's picture

Natgas is the oddball.

WTIC with overshoots removed

bearing in mind the 99-08 cycle's back has been broken until properly repaired

50MA still nose-down

 

http://img4.imageshack.us/img4/8792/1272.png

 

Wed, 09/16/2009 - 10:44 | 71025 Anonymous
Anonymous's picture

"If front month gas continues to move exuberantly, UNG (and CHK) will benefit"

UNG is no longer tracking the October contract. It has already rolled into November.

Wed, 09/16/2009 - 18:11 | 71676 Anonymous
Anonymous's picture

Not all of the roll is done. Takes 4 days, thurs is last day.

Thu, 09/17/2009 - 04:16 | 72093 Trading Nymph
Trading Nymph's picture

So True...they post it on their website...you know this happens every month when UNG rolls over...normally starts the week before when the EIA number comes out...and ends tomorrow when the EIA number comes out...cuz it almost always is above estimates...lets see if it will do it again...plus, if that stupid Aussie will finally stop going up and the USD FINALLY hit some type of support all the commodities that are so stupid to be up will flip.

Wed, 09/16/2009 - 03:42 | 70850 Mediocritas
Mediocritas's picture

I'm still cautious of UNG. Yes, they have now officially announced that they are issuing new shares so the premium should disappear but how that process plays out exactly remains to be seen.

Right now we're just seeing a bounce / short squeeze in play which isn't over yet. Fundamentals of US gas remain unchanged though. Too much production, no more storage and winter that sticks to script and turns out to be mild and we will see a fresh new low once the current short squeeze shakes out.

I had a long term short on UNG, trailing stop triggered at 10.5, no position now as I'm not prepared to hold UNG long. Recent long on XTO, nice entry at 37, took profits at 39.5 and 41. Intend to move back to net short nat-gas when it gets to 3.5 territory.

Wed, 09/16/2009 - 04:50 | 70860 slowtwitch
slowtwitch's picture

If your read their filing closely it is pretty vague on how consistenly they would be issuing new shares but they did devote an entire paragraph warning investors that if they are buying at a premium there is a great chance they would lost that. I still trade UNG on a daily basis but I only enter a trade when the UNG shares are moving inline with nat gas and also with its underlying NAV. I also never hold overnight anymore.

I agree that this is probably just a technical bounce/short squeeze play also but i don't think we'll see the bottom again. That said I've come realzie what other people have told me - nat gas is extremely volatile and hard to trade. So I guess anything is possible. It's gonna be hard for them to brush off the ever increading probability that storage may be breached before the injection season is over though so we should see the price come down.

Unfortunately I was unable to short UNG because my broker didn't have any shares for me to borrow but it was such a beautiful short. I do have a short on CHK though @ 28. Good luck!

 

 

Wed, 09/16/2009 - 05:23 | 70861 Mediocritas
Mediocritas's picture

It's quite likely that the squeeze will kick on as punters see UNG's issue of new baskets as a green light to pile on, assisted by CNBC breathlessly parroting the gas/oil ratio.

But I see that as just more moths to the flame. Export facilities aren't sufficient to deal with surplus production, with storage maxed out, wells are just going to have to be capped. Without a huge pickup in local demand (which is possible if the govt mandates it), there should be a consolodation/shakeout in the industry with price weakness. Hell, the bigger producers seem to be actively cannibalizing.

BTW, that entry short 28 on CHK is *exactly* where I would normally make an aggressive short entry for the quick pullback. Didn't take it this time though, squeezing too fast with volume and I don't have a good feel for the bears on this one (not comfortable to pick the top). Hope you pinned it.

Wed, 09/16/2009 - 08:54 | 70907 slowtwitch
slowtwitch's picture

Yeah you're probably right. The other reason i wanted to short UNG was to play the premium gap because I knew inevetiably they would start issuing new shares again. Once that's gone shorts will cover.

I've been playing UNG for 3 months now - buying on the dips and selling into the report. It's been working like a charm. I have a feeling that's what's setting up to happen this week as well. I bought some UNG this morning because it looks as though UNG may rally into the report tmrw. But yeah the fundamentals are awful and there's no getting around that - nat gas has to trade down.

I have a tight stop in place for CHK just in case.... It's hard shorting anything in this market and i keep getting burned but continue to try.

 

 

Wed, 09/16/2009 - 03:08 | 70843 Anonymous
Anonymous's picture

Interesting idea. To play devil's advocate, I would point out that reservoirs are over 90% fill, meaning that a lot of gas could get dumped on the market. Also, what if the winter is warm? Those calls could easily be a zero.

Wed, 09/16/2009 - 02:01 | 70818 slowtwitch
slowtwitch's picture

UNG is still trading at a 9% premium to its nav and between now and Sept-28th it will most probably start to dissapear because the fund may start issuing new shares then. So you will miss 9% of the move in nat gas prices via UNG. Be wary of UNG - for example today UNG shares were up 2.3% but it's nav was down 2.28%.... I have been trading UNG for a few months now and the ETF has become less and less reliable. Buyer Beware.

 

 

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