Can someone explain how the price gaps on NG work?

[nuclearmeltdown]

Using the most recent example, the NG Nov '17 contract expired on the 27th of Oct @ ~$2.75 while the Dec '17 contract was @ ~$2.95 on Oct 27th.

There was basically a $0.20 gap between the spot and the expected delivery price 4 weeks into the future, so that would imply that the spot/Dec contract would eventually converge by Nov 27th.

Based on this, it seems to be really obvious to long the spot price and short the Dec '17 future, but that's not the case right? Even if I wanted to long spot price, is there any way to do it? AFAIK, you can buy the Nov contract, but once that expires, you immediately roll over to the price of the Dec contract after.

However, when there are these huge gaps between spot price and current month, I feel like there has to be a way to exploit the gap, but I'm not sure how I would structure the trade in order to do so.

Anyone have any ideas on the subject?

 

[Maverick74]

Using the most recent example, the NG Nov '17 contract expired on the 27th of Oct @ ~$2.75 while the Dec '17 contract was @ ~$2.95 on Oct 27th.

There was basically a $0.20 gap between the spot and the expected delivery price 4 weeks into the future, so that would imply that the spot/Dec contract would eventually converge by Nov 27th.

Based on this, it seems to be really obvious to long the spot price and short the Dec '17 future, but that's not the case right? Even if I wanted to long spot price, is there any way to do it? AFAIK, you can buy the Nov contract, but once that expires, you immediately roll over to the price of the Dec contract after.

However, when there are these huge gaps between spot price and current month, I feel like there has to be a way to exploit the gap, but I'm not sure how I would structure the trade in order to do so.

Anyone have any ideas on the subject?

There is not a gap. Each month is it's own unique physically settled contract. There are strong seasonal differences in various months in natural gas. There is nothing to exploit here. The Nov contract is specifically for that date. If you owned physical storage, you could buy gas for nov delivery, take delivery, inject it into storage and if the cost of storage and transport was < .20, then you could store it and sell that gas into dec delivery. Without such storage there is nothing you can do.

 

[Overnight]

...

However, when there are these huge gaps between spot price and current month, I feel like there has to be a way to exploit the gap, but I'm not sure how I would structure the trade in order to do so.

Anyone have any ideas on the subject?

With something like this, you are confusing "spot price" with current month. There is no "spot", there is just the current month, or front month, or something along those lines in the vernacular. Then there is the "forward" month.

You are perhaps looking to take advantage of some sort of arbitrage here?

That can be difficult to do in physical commodities, since most forward months move in tandem with the current month at nearly the same rate in time. There are some exceptions I have noticed, like in HO. With skill and understanding I am sure this can be tackled successfully. Might want to ask @bone about this sort of thing, since he is a leading expert on spreads here.

 

[sle]

There is nothing to exploit here.

Well, there is a modicum of term premium, so something to exploit just not an arbitrage.

 

[bpr]

Using the most recent example, the NG Nov '17 contract expired on the 27th of Oct @ ~$2.75 while the Dec '17 contract was @ ~$2.95 on Oct 27th.

There was basically a $0.20 gap between the spot and the expected delivery price 4 weeks into the future, so that would imply that the spot/Dec contract would eventually converge by Nov 27th.

Based on this, it seems to be really obvious to long the spot price and short the Dec '17 future, but that's not the case right? Even if I wanted to long spot price, is there any way to do it? AFAIK, you can buy the Nov contract, but once that expires, you immediately roll over to the price of the Dec contract after.

However, when there are these huge gaps between spot price and current month, I feel like there has to be a way to exploit the gap, but I'm not sure how I would structure the trade in order to do so.

Anyone have any ideas on the subject?

There is no spot market here ...you are looking at futures current month vs next month ...

 

[maxinger]

You are talking about difference in price between near month and far month contract.

For some futures, near month price is higher than far month. Let's call it positive spread.
For some others, it is the other way round. Let's call it negative spread.

Spread is the difference in price.
Those who trade spreads are spreaders.

Now talk about +ve spread. Is it going to be even more +ve, or less?
Now talk about -ve spread. Is it going to be more -ve or less?

That's where you need to look at charts, and understand some fundamentals with regard to NG production, its inventory, political crisis in NG production country etc etc etc.

 

[Maverick74]

Well, there is a modicum of term premium, so something to exploit just not an arbitrage.

It's pure risk. Nothing to exploit. LOL. Winter gas trades at a premium for a reason.

 

[sle]

It's pure risk. Nothing to exploit. LOL. Winter gas trades at a premium for a reason.

If you remove the seasonality, there will be some residual term premium (positive or negative). It is a risky trade, nobody arguing, but statistically speaking it can be harvested. I have a good friend who does exactly that in various OTC energy products (ones with lower seasonality are more interesting, obviously).

 

[Maverick74]

If you remove the seasonality, there will be some residual term premium (positive or negative). It is a risky trade, nobody arguing, but statistically speaking it can be harvested. I have a good friend who does exactly that in various OTC energy products (ones with lower seasonality are more interesting, obviously).

That "residual' is the synthetic call option embedded in the curve for available storage capacity for the given term. So sure, selling a naked call on tight capacity in a constrained market during peak season does have some premium. There are better ways to make a living. But, yeah it's there if you want it. LOL.

 

[sle]

That "residual' is the synthetic call option embedded in the curve for available storage capacity for the given term. So sure, selling a naked call on tight capacity in a constrained market during peak season does have some premium. There are better ways to make a living. But, yeah it's there if you want it. LOL.

Partly, that’s true. Partly there is some level of mean reversion present probably and some is filtering through from the oil curve term premium.

But let’s say it is purely a synthetic call option (which it can’t be, since weather might also turn out unseasonably warm). There is nothing wrong with being short that kind of optionality in a reasonable size - at least it’s decorrelated from the equity markets.

Ps. This is becoming a purely theoretical discussion since neither of us will ever get involved in this type of strategy - I don’t want to argue for the sake of argument