Wednesday, May 2, 2012
Despite the rebound in Natural Gas futures this past week any significant rally attempts may run into strong headwinds from hedge selling as the market moves near chart resistance levels. Some traders who are expecting a continuation of the bear trend may wish to consider using the short-covering buying as a reason to explore selling calls in near-term Natural Gas futures options. For example, with June Natural Gas trading at 2.370 as of this writing, the June 2.650 calls could be sold for about 0.043, or $430 per option, not including commissions. The premium received would be the maximum potential gain on the trade, which would be realized at option expiration in late May should the June futures be trading below 2.650. Given the risks associated with selling naked options, traders should have an exit strategy in place should the trade move against them. An example of one such strategy would be to buy back the option prior to expiration should the premium of the option trade at 2 ½ times the amount the option was originally sold for.
Natural Gas bulls are finally getting a breather, as a short-covering rally has sent front-month June futures to nearly 1-month highs. This rally occurred after prices fell to lows not seen since 2002, taking front-month futures below the $2 level. The EIA reported that U.S. Natural Gas production fell 0.6% in February, which was the largest cut in production in 12 months. This view is supported by the Baker Hughes rig count data, which shows Gas rigs falling to their lowest levels in 10-years. Though it appears that low prices are starting to have some effect on dedicated Gas production, the market is still trying to absorb the Gas being produced as a byproduct of Crude Oil drilling. Gas bulls are hanging their hats on the continued switchover of power production to Gas-fired plants from coal helping to absorb what may become a burdensome supply of Gas in storage the remainder of the year. However, should Gas prices become more expensive then coal, we may see any increased power production demand begin to wane. The biggest potential for an increase in U.S. Gas demand is tied to the potential exporting of Liquefied Natural Gas (LNG) to Asian, and possibly European nations. However, this event will take some time, as in may not be until 2015 until a LNG export terminal is built and exports are able to ship LNG across the oceans. Market participants are holding a mixed view on the direction of Natural Gas prices, with small speculators and commercial traders on the long side of the market and large speculators holding a large but well-off a record net-short position. Much of the past week's rally may be tied to short-covering by these large speculative traders, and unless we see a clear positive shift in the demand or supply picture, commercial hedge selling may begin to enter the market should prices start to test recent highs near the 2.400 price level.
Technical Notes
Looking at the daily chart for June Natural Gas, we notice prices moving above the previous near-term resistance level at the April 3rd high of 2.335. This upward move may have triggered some buy stops as weak longs began to exit the market. Prices are now well above the 20-day moving average, which is lending some near-term support as short-term momentum traders are turning bullish. The 14-day RSI has turned positive, with a current reading of 60.01. The next significant resistance area is not found until the March 19th high of 2.607, with support found at the 20-day moving average, currently near the 2.141 price level.
Mike Zarembski, Senior Commodity Analyst