Traders who thrive on ferocious price movements crave the high octane volatility of the natural gas futures market. Few other commodities display the whipsaw action that makes nat gas one of the most difficult yet potentially rewarding commodities for speculative traders. Last August it lost 40% before jumping 93% in September. Having an effective hedge to offset potential instant portfolio destruction is essential.
Nat gas spec traders favor fundamental seasonal trends. The problem is that they trade the seasonal trends using logarithmic driven technical analysis. Since many hedge funds are playing the same strategy, money flows in and out like ocean tides. Getting caught out in high tide when the money flows have shifted to low tide has sunk several big name funds.
One of the most dramatic nat gas trading shipwrecks occurred in 2006 when Amaranth Advisors went all in on the seasonal trade of inventory builds from winter to spring known by market participants as "the widow maker trade". Fundamentally demand falls from winter heating season to spring. The problem with this trade is everyone knows about it and is playing it short, if they all head for the exits on any unexpected increase in demand for nat gas, the shorts have to buy their way out of the trade pushing the futures higher and creating more losses for anyone remaining short.
It is always best to enter these futures positions by adding insurance to the trading strategy with, in the case of a short nat gas futures position, nat gas call options. These options can be bought inexpensively at the end of winter, when call premiums are falling. Futures traders often prefer not to eat in to potential trading profits by purchasing options. The peace of mind the hedge brings, however, is well worth the cost.
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