The ACD Method

hoop121 · Mar 2, 2014

Maverick74 said:
Yes, I meant 30 day confirmation. I do my number lines different then Fisher. Mine are better.

Lol!!!

Robert Yanks · Mar 2, 2014

Hello Mav,

Perhaps you can post your 5 day for TLT.

Thanks

Trader13 · Mar 2, 2014

Maverick74 said:
Actually I think it's a great spreaders market. I find the correlations on the front strips to be very high against flat price with the bonus of added convexity...

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

KIRtrader · Mar 3, 2014

Maverick74 said:
Actually I think it's a great spreaders market. I find the correlations on the front strips to be very high against flat price with the bonus of added convexity. The issue here is the storage spreads. These are the ones that kill people and have very little correlation to flat price because you are betting on the final end of season storage number. Historically they overstock and the mar/apr spread is always over priced and it looks juicy to sell and get the free money. This winter was the worst in 50 years and the spread blew out. The issue here is there is no real way to hedge that if you are wrong because the term structure offers no value to the storage spreads.

The more I dig into the 1000's of spread combinations, the more interesting they become. There are some interesting dynamics further out in the curve with gas because of the future of this market i.e LNG growth, natural gas liquids and the role they will play, environmental considerations, etc. All these spreads further out have options embedded in there that are ripe for the taking. Some of those options are damn near free. All you have to do is find them. I think nat gas is by far the most interesting spreading market and I guess John Arnold would probably agree.

Hi Mav,

Could you please tell more about these embedded options? Are these the options on spreads or some optionality inherent in these spreads?

Maverick74 · Mar 3, 2014

Robert Yanks said:
Hello Mav,

Perhaps you can post your 5 day for TLT.

Thanks

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.

Maverick74 · Mar 3, 2014

Trader13 said:
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

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.

Maverick74 · Mar 3, 2014

KIRtrader said:
Hi Mav,

Could you please tell more about these embedded options? Are these the options on spreads or some optionality inherent in these spreads?

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".

Robert Yanks · Mar 4, 2014

Maverick74 said:
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.

Hello Mav,

Please don't do it. I was thinking you might be tracking this one and I wanted to check my numberline.

Thanks

KIRtrader · Mar 4, 2014

Maverick74 said:
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".

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?

Maverick74 · Mar 4, 2014

KIRtrader said:
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.