Pete Mulmat from the CME joins Tom and Tony to discuss various strategies surrounding natural gas futures. Trading futures outright can often carry more risk than trading futures calendar spreads. A futures calendar simply means entering opposite futures positions in multiple cycles. The main intention here is to offset risk. In addition to reducing risk, another key reason investors would look to enter into a futures calendar spread would be for the reduced margin requirements. This results in more efficient use of capital which allows for a potential higher return on capital.
The calendar spread itself is the price differential between the nearer term (front month) contract and a later dated (back month) contract. A positive spread means the calendar is trading in backwardation, or the front is more expensive than the back. A negative spread, however, means the spread is contango, or the back is more expensive than the front.
Natural gas price curves in particular are often cyclical and display some seasonality patterns. Generally it will rise in the fall and winter months due to increase in demand and decline in the spring and summer months as heating costs lower. These seasonality patterns yield short term contango and backwardated periods. Traditionally there is a lot of speculation on the price of the spread surrounding the winter/spring transition in the March/April spread. This spread is commonly known as the “widow maker” and is keenly watched by professional traders.
Pete discusses a few possible ways to trade the widow maker using the futures calendar spread itself as well as using futures options to take advantage of premium decay. Pete also goes into detail on a few key aspects to be aware of when trading these products. In particular, the natural gas futures calendar spreads trade as a separate product aside from the outright future, which allows investors to enter the spread in one order, which eliminates legging risk.
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