Report highlights

Image 1: Generic second-month futures price for Natural Gas

Natural Gas had a challenging start to the last year. In early 2024, prices were consistently below $2, and traders trying to play for the upside were often frustrated. I know this because I know I wrote bullish ideas for Natural Gas early last year for Excell with Options. There was a failed breakout in May/June 2024 where prices got above $3, only to go back to $2, that made things even more difficult. However, in October, prices once again broke out, this time above $3, and prices stayed here. The Ichimoku cloud, which shows an average of where traders are long and short, started to move higher, suggesting bulls were in control and the trend was turning. There's been a bullish tone to the market for the last four months. Can this continue or is this a longer version of the false break that was witnessed in the Spring of 2024?


Image 2: U.S. Department of Energy estimates of natural gas storage

As with all commodities, natural gas comes down to supply and demand. From a supply perspective, as a byproduct of oil fracking, natural gas is often an afterthought that producers will either sell on the market if the price is high enough or will flare off at the wells. Sure, there have been some moves recently to locate either bitcoin mines or data centers to attempt to take advantage of this source of inexpensive fuel. However, price has often served as the key to whether gas came to market or not. Once above some threshold breakeven price, though, it all comes down to demand. Much of this demand is then seasonal, as storage grows into the winter months and then draws down as the weather is cold and people heat their homes. A warmer-than-expected winter last year left inventory higher, leading to oversupply due to the lack of heating demand. From the U.S. Department of Energy graph above, the storage is already down more than last year.T This has to do with the colder temps across the U.S. Higher demand has added to the bid traders have seen in recent months to futures prices.


Image 3: Weather outlook for end of January and early February from the NOAA

If weather is a big driver in the winter months for demand, and therefore price, it is important for traders to consider if the cold temperatures of early January could continue, or if the warmer temperatures toward the end of the month will persist. The NOAA puts out an 8 – 14-day weather forecast for the entire U.S. in which one can see if temperatures will be normal or above/below normal. This graph is color-coded and shows a viewer where across the country they will see the colder or warmer temps. The graph above shows that a lot of the country in the Plains, mountains and out west will be colder than normal, with the Pacific Northwest noticeably colder. The warmer temps span from Texas and will cover the Southeast but even stretching up into DC, Philly and even NY. The upper Northeast is more likely to use heating oil than natural gas, so one needs to factor in what areas will use natural gas and what demand could look like in those areas. A quick review of the cities that use the most natural gas for heating is (in order): Chicago, NYC, Boston, Denver, Twin Cities, Philly, Detroit and Indianapolis. Of these, Chicago, Boston, Detroit and Indy appear to be near normal. Denver and the Twin Cities look colder than normal, while NYC and Boston look colder than normal. A mixed picture to say the least, but also not the strong picture of demand that's characterized early 2025 thus far.


Image 4: Commitment of Traders report for natural gas managed money positions

Turning now to the supply and demand picture for the futures market, I look at the Commitment of Traders report, particularly for managed money positions. I compare this to positioning over the last three years. The net position is the yellow line. Looking at this, I see that managed money is the longest it's been over the last three years. In fact, the last time it was close to this long was in the false breakout traders saw in futures in May of 2024. Traders know what happened to prices at that point. Could this be another case of faster money positions looking or a continued bid to the futures market, only to be somewhat disappointed by the demand picture being not as strong as it has early this winter?


Image 5: Top chart: CVOL Index for Natural Gas compared to the underlying futures price Bottom chart: Skew ratio for Natural Gas options compared to underlying futures prices

It's time now to turn to the volatility market. The top chart shows the CVOL index for Natural Gas as compared to the underlying futures price. Once prices came off their peak in early 2023 and stabilized, volatility also fell lower from above 100% and has been in a wider range. Volatility hit a low of 50 as futures struggled to find a bid, but as 2024 ended, volatility was again above 100%. After the holiday season, volatility has sold off but is largely in the middle of a wider range. The more interesting story may be the Skew Ratio, which shows the relative demand for upside vs. downside options. This level has moved higher throughout the bid to futures and at nine vols is currently at the highest level it's been since late 2022. Does this demand for upside options suggest the market, which is already long futures, is also long options and potentially underpricing downside risk? That'd be my takeaway, particularly concerning the co-movement between the Skew Ratio and futures prices.


Image 6: Expected return and option Greeks for a long LN2G5 3.05-2.95 put spread vs. short 3.55-3.65 call spread

Putting this all together, I'm inclined to position bearishly given the potentially crowded positioning I see in the Commitment of Traders report and the elevated Skew Ratio levels. I'm worried that a moderation in weather could see demand levels subside, and storage amounts return to longer-term trends, creating a supply/demand imbalance. With prices above breakeven rates for frackers, the supply may still be constant as the drill decision is driven more by oil prices than nat gas prices, as long as prices are above breakeven levels. The technical chart suggests a move below 3.15 could lead to a breakdown in futures and more selling pressure. The higher Skew Ratio allows one to sell upside options at higher implied volatility than the downside options they buy. However, it must be recognized that in a product that trades on an implied volatility of near 100%, leaving uncovered wings may not be suitable or even allowed by many brokers or risk managers.

I use this information to consider selling a tight 3.55-3.65 call spread and using the proceeds to buy a 3.05-2.95 put spread. If futures stay between 3.05-3.55 (currently at 3.29), there'll be no loss as the spread is premium neutral. The maximum loss is the difference between strikes and the maximum gain is as well, so the reward to risk is 1:1 but I am banking on the possibility that the odds of a move below 3.05 are higher in my analysis than a move above 3.55.

With the new Weekly options from CME Group, I'm able to do this looking out less than two weeks from now. This makes it a short-term tactical trade based on positioning and the interpretation of the market of the weather forecasts and then the reality that the market observes. With futures right at support levels, a short-term tactical idea is appealing to me, and weekly options afford this luxury. These LN2G5 options expire into the March futures which is important to consider when evaluating the levels and the idea. These are Friday options which are available to traders. As of Jan. 27, Monday through Thursday expirations are available as well. This provides even more flexibility for traders to customize their positions to specific catalysts, every day of the trading week.

The tools to analyze and the products that allow more customization of views is the strength of the CME Group platform. All of that is on display as one looks at trade ideas in the Natural Gas Weekly options.

Good luck trading!



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