Natural Gas ETF Pulls Back to Key Call Strike

Traders sold premium on the natural gas futures tracker ahead of a big surge higher in commodity prices

Dec 18, 2018 at 9:39 AM
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While stocks were taking a drubbing during the month of November, natural gas futures were in the midst of a high-volatility move of their own -- albeit in the complete opposite direction. The United States Natural Gas Fund (UNG) wrapped up last month on a gain of 39.8%, which marked its biggest monthly advance in a decade (and which contrasted all the more impressively with a meager 1.9% rise in the broader S&P 500 ETF Trust, and a 22% plunge in UNG's "cousin" vehicle, the United States Oil Fund).

To underscore even further the near-vertical nature of UNG's November ramp, it's irresistible to avoid pointing out that the exchange-traded fund (ETF) collected all three of its biggest daily gains of the past two years last month -- on Nov. 14 (+18.90%), Nov. 16 (+11.42%), and Nov. 28 (+10.54%). So yes, the overall November performance by the fund was not too shabby at all, considering that UNG's total share price gain through the first 10 months of 2018 was a comparatively quiet 14.5%.

But the commodity's rapid run higher seems to have reversed almost as quickly as it occurred. After a few weeks spent appearing to test its footing around a 10% correction from its mid-November high of $39.87, UNG gapped lower twice last week -- once on Wednesday, to the $33 level, and again on Friday, down to $31. The stock closed the week just below the latter price point... and subsequently, just below its 40-day moving average (which previously served as support in early November following the late-September breakout above the 320-day trendline), as well as the $31.89 level that marks a precise 20% drop from its recent peak.

And as we enter the week in which standard December options are set to expire, the $31 area takes on another layer of significance: It's home to peak open interest for the series, with 7,875 calls in residence at this strike price. Notably, a review of the volume history at the December 31 call suggests the bulk of these contracts were sold to open on the supremely inopportune date of Nov. 13, just ahead of a historically massive single-day rally for UNG (to be followed by an encore performance just two days later).

For those who may be thinking to themselves that this story is starting to sound familiar, there's a fair chance that you read last month about the implosion of a hedge fund that sold naked calls on natural gas futures just ahead of the aforementioned parabolic move higher. According to our research, there were no December-dated calls involved in that firm's ill-fated recommendations -- but unless these soon-to-expire bets were sold against a long position on natural gas futures, it's reasonable to speculate that the outcome for the seller(s) of these December 31 calls was somewhat similar to that of the hedge fund's clients.

Meanwhile, as we've noted previously, seller-driven open interest at near-the-money strikes tends to have a volatility-dampening effect on the underlying as expiration approaches. And while the magnitude of the open interest at the UNG December 31 call isn't quite substantial enough to influence the trading action in natural gas futures, we'd expect that the commodity's call writers would certainly welcome such a respite from the fourth quarter's wild volatility.

ung daily chart 1214

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, December 16.


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