Natural gas prices have continued to come under pressure and reach new lows, while crude oil has sharply rebounded from its lows. The North American natural gas market is almost entirely produced within North America, and recent industrial cuts due to the economic recession has caused severe demand destruction. However, unlike many other industrial focused industries, such as coal, steel, and other metals, supply cuts have not been profound among the natural gas producers.
It seems that those cuts may be coming this summer that could cause a very big spike in prices, due to the elasticity of natural gas prices, and large institutional option traders have been positioning for major gains among the companies heavily tied to natural gas.
Many of the natural gas related names have already begun to move higher as investors put money to work in the names ahead of the anticipated pricing rebound. The markets are generally forward looking and the stock price action is one indicator that natural gas is prepping for a recovery.
I follow the options market every day and I have always been very good at noticing trends, so when I began to see very risky, although with high reward, strategies being taken in the options market for many of the natural gas stocks, it sparked my interest.
One of the first trades was in XTO Energy (XTO) on Thursday, which is one of the most volatile stocks tied to natural gas prices due to the lack of hedging. The trade was a 5,000 contract risk reversal trade, with a trader selling 5,000 November $30 puts to finance part of the purchase of 5,000 November $40 calls in XTO. This is a very large monetary bet that could also lead to huge losses for this trader if XTO were to fall below $30, but this also shows the amount of confidence in the stock moving higher in coming months. This same trade was later duplicated at the May $28 strike for 2,500 contracts.
Many of these companies will report earnings this week and I expect to hear some bullish comments from the CEOs as to where prices are heading. The valuation on many of these companies is at historic lows, leaving a lot of room for upside moves in share prices. Many of the names have also been popping on my radar as nearing technical breakouts as well.
If you want to own stocks with cheap valuation, bullish technical signals, and large amounts of money being bet by the "smart" money, natural gas stocks are the place to be for the summer.
Some other names to invest in include Apache (APA), Devon (DVN), Penn Virginia (PVA), Denbury (DNR), Chesapeake (CHK), Anadarko (APC), Ultra Petro (UPL), Williams (WMB), Range Resources (RRC), SouthWestern Energy (SWN) and EOG Resources (EOG).
Risk Reversal trades can be a very lucrative way to play these names, selling puts at strikes near lows/support on the stocks, and using the money to purchase out of the money calls. It is a great way to lessen the cost for the calls and making a stand that shares have seen lows, and things are not going to worsen anytime soon.
Disclosure: I own XTO and am considering ownership in SWN, MUR and UPL