While crude oil grabbed a lot of the headline attention in late autumn, there's another mover in the energy sector that deserves to share the spotlight - natural gas!
Having slumbered in a low price/low volatility trend for several years, the natural gas complex roared to life recently, gaining more than 30% October/November - a breathtaking ascent.
The contrast between crude oil and natural gas price direction has also been rather startling to behold - given that the two normally share a positive correlation. Watching crude slide 20%+, alongside natural gas rallying 30%+, just isn't that common of an occurrence.
Fortunately, these developments probably haven't gone unnoticed by longtime tastytraders, especially because the Crude Oil and Natural Gas Ratio has been oft-covered on the tastytrade network. The Oil/Gas Ratio is a method by which energy market participants measure and follow the price of oil relative to the price of gas.
Using historical price data, the Oil/Gas Ratio provides traders with valuable insights into the behavior of this price relationship over time. The chart pictured below highlights the value of the Oil/Gas Ratio throughout the last several years:
As you can see in the graphic above, the Oil/Gas Ratio had ranged between roughly 13 and 26 since November 2015. Looking at current prices, which are about $55/barrel in crude and $4.70/mmBtu in gas (As of November 21st, 2018), we can calculate the current Oil/Gas Ratio as $55/$4.70 = 11.70.
Comparing the current value of the the Oil/Gas Ratio (11.70) to the historical chart above, we can see it has plunged below even the lowest part of the range observed in recent years.
Market participants in the energy sector often use extreme levels in the Oil/Gas Ratio as a signal to potentially deploy a pairs trade that utilizes crude oil and natural gas futures.
When the Ratio falls to attractive levels, traders consider buying crude oil futures while simultaneously selling natural gas futures - a position that theoretically performs well when the Ratio moves higher (i.e. reverts to the mean). Given recent price movement this would represent a contrarian trade in both commodities - buying crude after a dip, and selling gas after a rally.
The reverse position is considered when the Ratio is at the higher end of the range.
If you’re looking to learn more about trading the Oil/Gas Ratio, we recommend reviewing this previous installment of Closing the Gap - Futures Edition when your schedule allows.
Additionally, a newly released episode of Closing the Gap provides a timely update on the energy trading environment, and also outlines a sample trade involving natural gas futures options. Finally, this episode reviews seasonal patterns in natural gas trading - Market Measures: Seasonal Trading in Natural Gas.
If you are new to the space, and don't feel comfortable trading any of the aforementioned positions "live," you can always mock trade them and watch how they behave over time. Mock trading allows us to gain valuable experience in the markets without the risk of capital losses.
For your convenience, the links to the aforementioned programs are as follows:
If you have any questions about this material, don't hesitate to leave a message in the space below, or reach out with any questions to @tastytrade on Twitter or send an email to firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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