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Nov. 26, 2014, 10:20 a.m. EST

Cold-weather rally masks massive supply in natural gas

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About James Cordier

James Cordier is founder and head portfolio manager of OptionSellers.com, where he has managed assets for a global client base since 1999. He is regularly quoted by national financial media including the Wall Street Journal, Barrons, Forbes, CNN Money and Dow Jones Newswires. He is a regular guest analyst on CNBC, Bloomberg Television and Fox Business News. In 2014, James launched his 3rd edition of The Complete Guide To Option Selling, published by McGraw-Hill. For more information, visit OptionSellers.com.

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By James Cordier

Last month, we published a column on our blog advising to look for an autumn rally in natural-gas prices as an opportunity to sell calls. That rally not only came right on cue, it has inflated call premium more than we expected.

The stark contrast of the current price rally compared to overbearing supply figures sets up a near-ideal situation for call sellers in the natural-gas market — bearish fundamentals; price rally feeding from public sentiment (cold weather); inflated option premium resulting from the price rally.

Fundamentals win the day

One of the core principles we write about is that your option sales in commodities should always be based on core supply/demand fundamentals — not public whims.

And fundamentals for natural gas remain decidedly bearish. Why?

Because during the U.S. late-summer and autumn months, distributors of natural gas begin accumulating supply to meet winter-heating needs. In the past, this has often added a layer of support to natural gas prices — at least in its early phases.

By December, this accumulation phase typically ends, as storage levels have typically hit numbers deemed adequate to meet winter demand needs. This takes demand pressure off at the wholesale level — and has in past years, tended to pressure gas prices. Storage supplies of natural gas typically top out in late November, early December.

The latest EIA figures indicate that as of late November, gas-storage levels topped 3.5 trillion cubic feet , which seems to be at the high side of the normal averages and could possibly be peaking for the year.

This is not bullish for prices and flies in the face of speculator’s emotional buying because "it's cold outside."

While storage levels often begin to drop in December as demand at the retail level begins to draw down storage supply, it is the wholesale demand that tends to drive futures prices.

The irony here being that at the time when retail demand is at it's highest (winter), wholesale demand (which drives futures prices) can be at it's lowest. Thus, prices have in years past tended to weaken in the winter months. While there is no guarantee this will happen in 2014, we certainly think the stage is set for a seasonal price correction in the coming weeks and/or months.

Trade suggestion

We don't know when the current rally in natural-gas prices will end. Fortunately, as option sellers, we don't have to know. Remember, as an option seller, you only have to pick what prices are not going to do. You don't have to bet on what they will do.

We do know that current fundamentals do not support prices above $5.00 per mbtu. Thus we want to sell call options at strikes far above that level. The latest wave of public speculation has made that possible.

In our managed portfolios this month, we’ll be looking to sell call premium in the natural-gas market at strikes of 8.50 or above. That's more than double the current price of natural gas. Premiums for the March Nat Gas 8.50 call recently traded at a $600 premium – a level we will be targeting for investors in December.

Have a great month of trading in December and we hope you hit your premium targets. We'll see you in the New Year!

Disclosure: Optionsellers.com currently holds short call positions in natural gas.

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