GOLDMAN SACHS WAS WRONG ABOUT NATURAL GAS….OR WERE THEY?
The rally in natural gas over the last month has been nothing short of breathtaking. Gas has rallied almost 100% since the bottom earlier this month. Late last month we pointed to a piece of Goldman research that expected the oil:gas ratio to continue to expand. In other words, they expected oil to remain strong in the face of stagnant or declining natural gas prices. Despite their research, Goldman also mentioned that they were closing out the trade for a nice profit. Talking about being wrong in theory, but right in reality! Someone that didn’t get the trade wrong is the unknown large hedge fund who purchased the deep out of the money calls on nat gas at $3:
A hedge fund has made a large bet that natural gas prices will triple by winter just as the price of the commodity slides to a seven-year low.
Traders took notice last week when the fund, as yet undisclosed, spent millions for the right to buy US natural gas at $10 (£6.03) per million British thermal units in January and February, up from Wednesday’s spot level just above $3 per mBtu.
Yet the hedge fund sees a chance of a spike. For months, an average 2,000 gas call options have traded each day for the New York gas benchmark contract. Last week, however, volume spiked one day as 10,000 January $10 calls were bought. Over the next two days, nearly 8,000 February $10 calls traded.
The slim chance of reaching double-digit territory was reflected in the price of the call options. January calls sold last week for about 5.6 cents, meaning that buying 10,000 contracts cost $5.6m.
Chris Thorpe, at Hudson Capital Energy, a New York options dealer, said the fund could be a winner even if the spot price did not reach $10. “If a 5-cent option goes to 10 cents, they’re happy,” Mr Thorpe said.
basic reversion to the mean, the ’smart’ hedge fund could had known that there should be some reflex bounce back soon due to the ‘rubber band’ affect. same goes for the stock market before last spring where a reversion back to the mean was eventually going to happen sometime by summer time.
You are ignoring the enormous contango in gas futures, which makes the numbers less impressive (although still impressive). The October contract’s last day of trading was yesterday. That was the front-month or “spot” price at the bottom in early September. It bottomed at $2.50 and peaked Friday at $4.00 — a gain of 60%, not 100%. Meanwhile, for this entire period, the November contract was a full $1 higher; it bottomed at $3.60 and is now $4.90, a gain of 36%. The October-November spread is merely a function of seasonality; gas inventories peak in September and then subside as households turn on their furnaces. January gas was yet another $1 higher; it bottomed at 4.72 and is now 5.95. So unless that options buyer timed things perfectly, they bought those calls when their underlying was above $5, not below $3, and their underlying has risen “only” around 20%.
Robert,
Good points. I don’t have the exact trade data so it’s impossible to know….
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