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June 15, 2016, 11:22 a.m. EDT

How air conditioning makes natural gas an attractive short trade

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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

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Opportunity for option sellers

With supplies at historically high levels and a strong seasonal tendency for weaker prices during the summer months, natural gas has nonetheless spiked in the opposite direction in June. This could be the function of a late "last gasp" seasonal top. But it's also likely due to speculators entering the market ahead of "air conditioning season." So far, 2016 has seen bouts of warm weather this spring. And with temperatures predicted above normal for the remainder of June, buying into the air-conditioning storyline gets easier for headline-driven specs.

This week's EIA storage report added an extra boost to speculative furor with a less-than-expected injections into storage. Injections were reported at 65 billion cubic feet (bcf). With expectations for a 79 bcf injection — the bulls took this as another sign that lower supplies and higher prices are ahead in the natural-gas market.

But they are not looking at the bigger picture. Overall supplies are at record levels — 32.1% above the average for this time of year — so seasonal tendencies overwhelmingly favor bears and the market appears to be perilously overbought.

Nonetheless, the latest spike upward has brought a surge in both volatility and call-option premiums. That makes selling call options an attractive and fundamentally sound strategy at present.

Natural-gas volatility chart

Natural Gas market volatility has helped increase call option premiums.

Fundamentals notwithstanding, there is nothing that says natural-gas prices must turn and head lower tomorrow. Markets can remain irrational longer than you can remain solvent.

That is why we sell call options and don't trade the underlying.

OptionSellers.com currently favors selling the December Natural Gas 4.50 call options. At the time of this writing, the call is valued at $450. Margin requirement per option is currently in the $1,000 range. A continued rally in gas prices should increase both premium and volume in natural gas calls, and thus, make this market a candidate for building a larger position.

December 2016 Natural Gas (NGZ)

Selling the December natural gas 4.50 call option

The specs may be having their way with natural gas in the short term. But the odds are against them. The forces of fundamental gravity should, in our opinion, eventually pull prices back down. You can bide your time by getting paid to sit way up at the $4.50 strike and wait it out. Should prices follow a normal seasonal pattern, you could be buying back near-worthless options within 90 days.

Of course, anything is possible in markets, and losses are always possible. However, in an age of negative interest rates, a nervous stock market and George Soros positioning for economic meltdown, targeting a 40% return in 90 days by simply betting against the improbable seems to be a rational and potentially rewarding investment approach.

It's a wonder more people don't learn how.

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