Makes sense with regard to its own futures curve and options. I was referring to opportunuties to spread against related markets. Unlike oil, where you have RB, HO, and Brent/WTI, nothing seems to correlate with NG. BTW ... point of trivia ... Brian Hunter, the Amaranth trader, was born in 1974. I think the stars were aligned that year to create traders
Hi Mav, Could you please tell more about these embedded options? Are these the options on spreads or some optionality inherent in these spreads?
I'm going to have to get back to you on that. Really swamped with work. I mainly track the 5 day on the bond futures vs TLT as TLT misses the price action of the 7:30 eco reports.
Actually nat gas does have a lot of stuff to trade against, unfortunately not for the retail guy. For example nat gas is spread against coal since it competes with coal for electricity generation. The official spread is called "the dark spread" or "dirty spread". Then you have the "spark spread" which is nat gas vs electricity. The PJM futures contract is usually used for this. Nat gas is in input variable for electricity generation. Then you have all the various locational basis swaps (over 50 of them). Then you have the heating and cooling degree contracts. Honestly the list is endless. Far more stuff to spread with gas then oil. Ironically oil is the one where you are kind of left out in the cold. The refined products are NOT hedges, they are actual independent unique end products. The crack spreads are actually synthetically replicating the profit margins of a refiner. They are taking his input costs and producing an output with the difference being his profit margin.
It's the optionality embedded in the spreads. The way to understand this better is to pretend you are a producer that has gas in underground storage which itself is a synthetic option. The producer via the forward curve can optimize his storage levels in the future based on his cost to store gas and his ability to transport the gas to a specific location at a specific time in the future. And since he is not "obligated" to do this, he has the "optionality".
Hello Mav, Please don't do it. I was thinking you might be tracking this one and I wanted to check my numberline. Thanks
Thanks Mav! So by saying these options are near free, you are talking about spreads that are cheaper than the cost to store the gas and transport it. Am i right?
It's a little more complicated then that. Think about it this way. The forward curve has a propensity to trade at a discount because there is a steep economic cost for the producer to store gas. The cost is implicit, not explicit. Meaning it's not an actual dollar figure per day that is his concern. Producers make money by actually "selling" their gas. Not trading it. They make money moving MMbtus. If you are still with me now, keep following...they would rather sell their forward gas below fair value because they get paid on volume more so then on price. So they exert downward pressure on the forward curve in certain spots. Since the forward curve trades pretty flat the price of the spread acts like an option. As you move forward in time, the curve is not acting like a storage market, it starts behaving like a delivery market. As you get closer to the delivery cycle the gas becomes more sensitive to supply constraints and the pricing structure changes. The sensitivity to backwardation becomes very high. Think of this gamma on an option. And the backwardation itself as the delta. Now think of the supply constraint as implied volatility on an option. Now in the equity world, you would have to pay for this right to own the convexity. However, the market in this case is actually paying you for it, hence the "free embedded option". Let me know if this is making sense to you.