hi,

I'm looking for spread traders to share ideas with.
i have been trading futures and future optinos for many years and am now looking into (future) spread trading.
i can find only a few threads about spreads so hopefully there are some people out there...

you can either reply on this therad or send me an inmail.

to make it a bit more concrete, i have been looking at the following spread:
sell NGH14 buy NGJ14
comment welcome,

have a good Xmas!

Hi kevin,

Instead of answering your questions let me ask you what you think the risks for this particular trade are and how you would trade it if you did.

One thing you need to remember is that not only is Natural Gas a real commodity, with real supply and demand, but it's also an essential commodity. If we run out of natural gas, power plants shut down and houses go dark, grandma's heater doesn't switch on and people can die. While this might sound sensationalist, rolling blackouts in the summer have caused people to die on several occasions, and the fear is real for many people. (Although I don't recall us ever actually running out of Gas in the winter). For this reason you can see scarcity pricing occur in Natural Gas (and even more so Electricity) that you will never see in other commodities. This also effects implied volatility and skew in ways you rarely see in other markets as well.

PBS did a documentary back in 2001, where they interviewed several Natural Gas traders including Bo Collins who would later become President of the NYMEX before it was bought by the CME. You can watch the show and see the transcript here. At one point Bo tries to explain scarcity pricing to the reporter by equating it to a man in a desert.

BO COLLINS: If you don't have water to drink, on your first hour of not having water, what will you pay for it?
PAUL SOLMAN: Well, I start to...
BO COLLINS: You don't care that much.
PAUL SOLMAN: Right, I don't care.
BO COLLINS: In... 12 hours later, you're a little thirsty; what's the value of water?
PAUL SOLMAN: It's getting there.
BO COLLINS: Two weeks later, if you're still alive, you'll probably give everything that you have in your bank account for that glass of water.

Interestingly Foster Smith another trader interviewed in the documentary makes the following comments about some 2001 price moves...

FOSTER SMITH: We basically traded from $5.70 up to $6.94 in two days, a pretty large move. We're talking about, you know, a 20 percent move in two days, which... that would be like the Dow going up 2,000 points in two days. That'd be a talkable event.
PAUL SOLMAN: And when the forecast changed just over the weekend...
FOSTER SMITH: Prices came off almost immediately. We opened up at $6.20 yesterday, which was down almost 60 cents, and it went down to $5.70 in about 30 minutes. So we lost everything we'd gained in two days in about 45 minutes.

Back to Natural Gas ... In the US, we use a lot more Natural Gas in the winter than we do in the summer. Since production is relatively balanced year round, we inject massive amounts of natural gas into underground storage April thru October and then remove it December through March. (At it's peak US Natural Gas stoarge represents approximately 15% of annual demand.)

Consumption is very weather dependant but nearly always highest in Januray, followed by December & February. Hence its not surprising that January is the peak of the curve when you look at prices on a forward basis. But if we have a very cold winter, and storage starts running low, it's not January you need to be worried about but March. No matter how cold it gets in January, there will always be enough gas in storage to meet demand. If we were ever to run out of gas in the Winter, it would probably be because of demand in January & February but we would actually run out in March. Hence we have the phenominoum that all the fear factor is pushed into March.

April on the other hand, is the first month of next years injection season. If we run out of gas in March, prices will be higher in April and through out the summer than normal, but not that high, and we will never run out of gas in April. Hence April always has to price itself as the first injection month for the following winter. Hence March prices have the potential to completely detach from April and beyond pricing.

Now consider what happens if we get to March and we have plenty of natural gas. The gas in storage that won't get used now has to price itself to stay in storage for the following winter. Hence March drops to a discount to April! As you can see the dynamics of the March-April spread can vary enormously! If the price dynamics of March seem like they can be a roller coaster - just imagine what the implied volatility can do! To make things even more interesting, CME and ICE both trade and clear, spread options on the March-April spread.

When Bo Collins left his position of NYMEX President he set up a hedge fund called Motherrock. After some early impressive gains the Hedge Fund went down in 2006, rumored to having lost over $200M trading March-April NG spreads and associated option contracts. They were squeezed out by Brian Hunter and Amaranth. In the next 12 months Amaranth went on to lose $6.6 Billion, a lot of which was again lost in March-April spreads (and also Oct-Jan spreads). The big winners were rumored to be Centaurus (aka John Arnold), Citadel and JP Morgan. If you would like to see some interesting implied vols try and get some historical quotes for upside March'06 and March'07 calls.

March-April is the ultimate fear trade, short squeeze trade, and path dependent trade. Every year it trades at a significant premium, and in most years it settles at flat or more often negative (2003 settled $1.74). The question is, can you handle the drawdowns before this happens. Even this year with the much smaller 40c moves, lots of money is rumored to have changed hands.

I know this sounds very sensationalist, and in reality the current increased supply picture means the prices we saw in March-April in the 2000's probably won't materialize again soon. But the facts are Billions have been lost trading this spread over the years.

March April through the Years ($/MMBtu)

March April through the Years (March % Premium to April)

Last 5 years March April