UNG: The Effects of Contango

I have very little to say here as a picture is worth a thousand words.

If you have followed my posts and comments, or those of many more knowledgeable Seeking Alpha participants, you are by now aware that UNG has changed the way it attempts to accomplish its goal to avoid possible CFTC limits. You are also aware of the issue of negative roll yield during periods of contango.

These issues have been described, but the words you have read may not have had as dramatic an impact as the below image.

The below partial "snapshot" of this UNG Daily Holdings web page, on Wednesday 10/14 at 21:16 EDT, tells the whole story. Note that it changes daily, so the contents may vary depending on when you visit the page.

(Click to enlarge)

Do the math and note the reduced number of positions after completion of the next three roll periods (hint: -7,955?). On a part of the page above that is not shown in the "snapshot", the total holdings after the first roll day was completed are 180,960 positions. If price ratios remain unchanged over the next three rolls, the net positions will decline a further 4.4%.

To add insult to injury, the November futures contracts (the current UNG position being exited) has begun the expected price decline and the December contracts (the position being entered) are also declining now, albeit more slowly than the November contracts. If the futures contract prices continue to decline, UNG will again own fewer contracts which are declining in value at the end of the roll period.

While writing this article, I checked the previous session contracts. November showed a -$0.152 decline to 4.436 and December showed a decline of -$0.118 to $$5.357.

Prior to the start of roll, the NG:UNG price ratio was 2.39:1. After roll is completed, if nothing else changes, we can expect 2.285:1.

Note that this is also options expiration week and that can have an effect on UNG prices if short covering is in play.

Go to the Nymex Natural Gas current session contracts to see current prices. You can also select the previous session to see what prices were at close of the previous session. Click on one of the contracts to bring up a chart, which can be used to show various intervals.

Premium paid at end of 10/14 was +3.77% (NAV $10.60, market closing price $11.00).

The new prospectus is available from the UNG website in PDF format under the Literature drop-down menu.

Disclosure: long UNG, short covered calls, long synthetic short positions.

Comments

[JimmyUSA:]

I been reading your articles and find them informative, thanks!
Another thing is that I don't think APPPRO was being too rude. Most or all articles have a point (or at least the readers would expect one.) APPPRO was asking reasonable questions (though he/she could had asked them in a more kindly way.) If you don't have good answers respectively say so like most or all good commentary writers. Instead you write a lengthy mean-spirited defensive reply to a poster who wrote a very brief comment (about 100 letters.) Calm down and don't get overboard over other posters. Otherwise you shouldn't be posting articles if you can't take criticism at all.

Oct 16 12:59 AM

[apppro:]

Jimmy, thxs for your comment, but why bother. All us bloggers are just that - bloggers - and if the author of any blog has such thin skin then as Maria Bartiromo says, "That's what makes a market."
A conspiracy theorist might say that Dr. Love really is very short UNG and not as declared Long. That same skeptic would also ask as you did as to why Dr. Love just didn't answer my question instead of pooh poohing it or referring me to some obscure Google search. By the veracity of his response, "Me doest think he protest too much!"

In any event I don't care and thanks again.


On Oct 16 12:59 AM JimmyUSA wrote:

> I been reading your articles and find them informative, thanks!
>
> Another thing is that I don't think APPPRO was being too rude. Most
> or all articles have a point (or at least the readers would expect
> one.) APPPRO was asking reasonable questions (though he/she could
> had asked them in a more kindly way.) If you don't have good answers
> respectively say so like most or all good commentary writers. Instead
> you write a lengthy mean-spirited defensive reply to a poster who
> wrote a very brief comment (about 100 letters.) Calm down and don't
> get overboard over other posters. Otherwise you shouldn't be posting
> articles if you can't take criticism at all.

Oct 16 07:08 AM

[H. T. Love:]

I appreciate your thoughts.

If I shouldn't be posting to this site, click the report abuse button and SA will do whatever they do. Or, as you have done, post a comment and others can see your POV and decide for themselves. I consider that constructive and you presented in a constructive way, in my opinion.

I stand by my response, which "clarifies" the point made in the second paragraph of the article.

"These issues have been described, but the words you have read may not have had as dramatic an impact as the below image."

The reply also explains why I choose not to comment on things of which I'm ignorant.

Go take a look at the profile of apppro and note the comments rating. Read some of them. Note the % of "constructive" ones.

I have zero tolerance for those that consistently ... "behave badly" in my opinion. My efforts here are to share what one n00b learns with others that may be n00b also. I give, to the best of my ability, constructive interaction and look for the same in return.

If one "behaves badly" in my opinion, I feel it's "socially responsible" to offer thoughts about that behavior and maybe they learn something from it. Maybe not. But it's not an "ego thing" or an emotional thing with me. It's just part of the process, hopefully rarely.

And I'm not concerned with what other authors do.

As a last thought, if you go through my past comments, you will see that I *rarely* adopt such a tone and am pleased when folks participate in a constructive manner even if it is a constuctive criticism of something.

Thanks again,
HardToLove

On Oct 16 12:59 AM JimmyUSA wrote:

> I been reading your articles and find them informative, thanks!
>
> Another thing is that I don't think APPPRO was being too rude. Most
> or all articles have a point (or at least the readers would expect
> one.) APPPRO was asking reasonable questions (though he/she could
> had asked them in a more kindly way.) If you don't have good answers
> respectively say so like most or all good commentary writers. Instead
> you write a lengthy mean-spirited defensive reply to a poster who
> wrote a very brief comment (about 100 letters.) Calm down and don't
> get overboard over other posters. Otherwise you shouldn't be posting
> articles if you can't take criticism at all.

Oct 16 07:25 AM

[H. T. Love:]

On Oct 16 07:08 AM apppro wrote:

> Jimmy, thxs for your comment, but why bother. All us bloggers are
> just that - bloggers - and if the author of any blog has such thin
> skin then as Maria Bartiromo says, "That's what makes a market."
>
> A conspiracy theorist might say that Dr. Love really is very short

I'm not a docotr or lettered in any way.

> UNG and not as declared Long. That same skeptic would also ask as

Believe as you will, but I never lie.

> you did as to why Dr. Love just didn't answer my question instead
> of pooh poohing it or referring me to some obscure Google search.

Read my reply to Jimmy. I've nothing to add to that.

> By the veracity of his response, "Me doest think he protest too much!"

Well, everybody has an opinion. You're entitled.

>
>
> In any event I don't care and thanks again.

HardToLove

Oct 16 07:32 AM

[H. T. Love:]

On Oct 15 09:32 PM lca13 wrote:

> I have placed some directed graphs showing arithmetic price possibilities
> due to contango rolls at unginvesting.com

That's a great display and discussion. I bookmarked it. I hope you have time and interest to augment it as time passes.

By the way, does it (need to) account for the ICE 1/4 sizes that ct gas pointed out? I overlooked that in my article.

It seems to me that you could post an instablog right here on SA or even make an article as updates warrant.

I think all of us would find it very useful. And all these "nuggets" we give to each other will help us all!

Thanks again,
HardToLove

Oct 16 07:48 AM

[relayer75:]

Good article. UNG is a p.o.s., and those that continue to foist this wholly flawed ETF on a predominantly unsuspecting public should be hoisted up by their own petards and maimed, repeatedly. It is nothing but a tool for separating retail investors from their hard-earned money.

Oct 16 09:33 AM

[Nghia Vo:]

H.T. Love,
So today natural gas price jumped more than 4%, what do you say now above UNG 'roll-over' theory ? It sounds to me that your article is hard to read.

Oct 16 10:46 AM

[fji:]

Much appreciated.


On Oct 15 01:35 PM H. T. Love wrote:

> On Oct 15 12:56 PM fji wrote:

Oct 16 11:09 AM

[Alok Swain:]

Hi H.T.Love

Good article.

I however didnt understand your disclosure very well. Could you please clarify.

It says and I quote "Disclosure: long UNG, short covered calls, long synthetic short positions"

I understand "long UNG" and shorting "short covered calls" but what does "long synthetic short positions" mean. It kinda sounds contradictory.

Please explain.

Again very informative.

Regards,

Alok Swain

Oct 16 12:06 PM

[H. T. Love:]

Yes. But as I try to remember to state, I'm new and learning. Seasonal and sentimental views and other more knowledgeable folks actions and opinions affect things and give me a good risk for being shown wrong. If I want to learn and contribute, it's a risk I must take.

My big hope is that folks do their DD and don't just rely on any words I may write.

As to today's rise, there have been many before since I started posting. There will be many more. There also have been many *more* times, so far, that I seemed to have gotten it right. So I don't feel that all I've learned so far is wasted. That's my big fear - that learning has been fruitless.

I keep an eye on things and try to adjust my view to fit new facts (my ignorance in so many areas, still, is my biggest liability). And I still keep trying to learn new stuff.

I did OK on my prognostications through about mid-September. Maybe because only technical and/or fundamental analysis was involved.

Then as the "seasonal" things kicked in, I was "slapped with a clue-bat" as this was my first season involved with NG and did not realize how strong these influences were.

However, regarding UNG, a brief rise because the underlying NG is having it's day doesn't convince me I'm wrong (yet) about it. I believe it's strength will show when contango disappears. I have been advocating that folks who want to get in early use options for protection or garnering some income while they wait for contango to dissipate. The Feb-May contracts are showing this possibility now and an entry just ahead of that period, if the pattern holds or continues to build, seems reasonable to me.

I have consistently advocated looking for the contango to dissolve as a possible good entry point.

Since UNG was up in the mid-$16 range in June, $13-$14 Jul-Aug, hit a low of $8.94 on Sep 03, and is at this moment back to $11.55, I don't feel that I've missed to badly over the time I've become involved. And if anybody did DD and saved themselves some money, or avoided entering too early, because of my past posts, then I feel I've helped someone else that is new like me. And that's all I'm trying to accomplish.

I always *try* to remember to warn that I am new, that season and sentiment could have strong influence, etc.

But none of that affects the technicals of negative roll yield inherent in UNG. As I've stated many times, a sufficient rise in the front-month prices could overcome that deficiency and I hope, for the sake of those that jumped in "early" that it works out for them. I hate to see any of us small investors get fleeced by ... "unsavory actions" of those with more/insider knowledge. I feel so many jumped in based on advice from "sell siders" or wanting to "go green", rather than doing their DD. Ones jumping in now or later may do OK. Winter weather, economy, E&P and producer actions, etc. will determine that. But those who jumped in back in the late May time-frame (in my previous articles are some charts where you will see *HUGE* volumes around 5/28-5/29) may have a hard time coming up to break-even if the fundamentals, weather, economy, etc. don't cooperate. It is made more difficult by the current contango that does affect UNG.

As to "hard to read", I'm not an author by profession and so I'm sure I miss that mark a lot.

As to "have I really learned enough to get it right sometimes", I hope so. But I'm prepared for brickbats that I know must come when I miss big on my way to becoming "competent".

If you would like to judge for yourself, you can click on my avatar and there you can view past articles, instablogs, comments, etc.

HardToLove


On Oct 16 10:46 AM Nghia Vo wrote:

> H.T. Love,
> So today natural gas price jumped more than 4%, what do you say now
> above UNG 'roll-over' theory ? It sounds to me that your article
> is hard to read.

Oct 16 12:17 PM

[Mayascribe:]

Hard: Please check your email. A request has been made.

Oct 16 12:28 PM

[H. T. Love:]

On Oct 16 12:06 PM Alok Swain wrote:

> Hi H.T.Love
>
> Good article.

Thank you.

>
> I however didnt understand your disclosure very well. Could you please
> clarify.
>
> It says and I quote "Disclosure: long UNG, short covered calls, long
> synthetic short positions"
>
> I understand "long UNG" and shorting "short covered calls" but what
> does "long synthetic short positions" mean. It kinda sounds contradictory.

That's the term I learned from Tom Armistad(sp?). I had been playing with calls and puts and wondered what the net effect was of a short call/long put. As he explained it, it simulates selling the stock short, with a lot less money involved. It consists of selling a call (covered in my case) and buying a put. Same expiration months and strike.

If you correctly guess the stock is going down in the time frame, in both magnitude and time, the gains simulate a short position. The value of the call declines (meaning you're more likely to keep all/most of the premium you received) and the put value increases and you can sell it at a profit, or exercise it if you want to sell the shares the puts protect at a higher than current price.

Of course, time-decay determines a lot of the potential. If you miss the time-frame too much, gains may be minimal. And if the direction is wrong, you can also lose. And if the magnitude of the move is not big enough you may lose some of what you took in as premiums on the short side.

The biggest trick for me is trying to open the position when the stock is high and seems ready to turn dramatically.

HardToLove
>
>
> Please explain.
>
> Again very informative.
>
> Regards,
>
> Alok Swain

Oct 16 12:39 PM

[H. T. Love:]

Baker-Hughes gas rig count down 5 this week to 721. Only second time in 13 weeks.

Might bump NG some more, but as the rigs from previous 13 weeks come on-line ... who knows?

HardToLove

Oct 16 01:07 PM

[H. T. Love:]

Just ran across this article indicating September industrial production up .7%. Capacity utilization up to 70.5%.

This would indicate more NG usage, regardless of weather, because EIA figures that I calculate indicates industrial consumption is 28.96% Oct-Sep 2006-2007, 28.94% same months 2007-2008 and 26.35% Oct 2008 - Jul this year.

Sounds good, but let's keep in mind that everyone expected an uptick in 3rd quarter from "cash for clunkers" and inventory restocking.

In another comment I posted here,

seekingalpha.com/artic...

we had a net drop in *total* usage through July averaging -5.1%.

Just wanted to post this so folks can consider whether the uptick in industrial use can count on the capacity utilization continuing high or if it was, indeed, just a one-time boost from the clunker and restocking actions.

If it continues, we should see greater use of NG. If it was a "blip", then we may see larger than expected net injections if the weather doesn't do a really big number (commercial, residential and generation combined looks like 65% of usage over the last few years on an "eyeball" basis - i.e. I didn't calculate the average of those years). I mention those usage categories because adverse whether seems to me to increase consumption in those areas.

HardToLove

Oct 16 03:39 PM

[Johnni:]

UNG has increased its mandate to include total return swaps. And we can see from the post that they is using this option. But aside from counterparty risk, why is this bad? It is just another tool in the tool box to do the job. Currently there is frontrunning and the diluting capital bleed at each roolover. For me it seems the new amendment is a step in the right direction.
what am i missing or misunderstanding, will someone put me straight?

Oct 16 06:06 PM

[John Lounsbury:]

HTL - - -

Congratulations!

You got picked up on a Financial Times reading list.
ftalphaville.ft.com/bl.../

Oct 16 09:47 PM

[H. T. Love:]

John,

I know you won't believe this, but I *swear* it to be true.

The very first thought when I read your words was "What sort of fool makes up that list"?

After some consideration, I'm still dubious about inclusion on the list, but have to consider the possibility that I'm wrong about it.

Thanks for posting - I would not have noticed.

I guess I'll have to go off now and beat my ego back into submission! ;-))

HardToLove

On Oct 16 09:47 PM John Lounsbury wrote:

> HTL - - -
>
> Congratulations!
>
> You got picked up on a Financial Times reading list.
> ftalphaville.ft.com/bl.../

Oct 17 06:11 AM

[H. T. Love:]

I'm really to ignorant to offer an authoritative answer. What I've gleaned from reading so far has focused on the counter-party risk. It *seems* to me that UNG has done their best to mitigate that. This article describes the steps UNG has taken that makes me believe that.

seekingalpha.com/artic...

Now, purely as a *guess*, I think there might be worry about the clearing function. If I understand correctly, the clearinghouse not only mitigates conterparty failure risk, but prevents some types of shenanigans.

But as I state, it is only a guess.

Personally I felt that the delay in new issuance after SEC approval so that UNG could get mechanisms in place to best meet the objectives was a good reflection on them.

However, for investments there is still the issue of the structure of the fund combined with contango and that is a mechanical effect that will always exist as long as contango is in play.

I'm sorry I can't be more definitive in answering your question.

HardToLove


On Oct 16 06:06 PM Johnni wrote:

> UNG has increased its mandate to include total return swaps. And
> we can see from the post that they is using this option. But aside
> from counterparty risk, why is this bad? It is just another tool
> in the tool box to do the job. Currently there is frontrunning and
> the diluting capital bleed at each roolover. For me it seems the
> new amendment is a step in the right direction.
> what am i missing or misunderstanding, will someone put me straight?

Oct 17 06:26 AM

[H. T. Love:]

Well, with Dec NG futures contract from prev session @ $5.935 and UNG NAV @ 11.81, the new ration sems to be 1/9898, much worse than I expected.

HardToLove

Oct 21 09:08 AM

[H. T. Love:]

Trying again, ratio 1.9898


On Oct 21 09:08 AM H. T. Love wrote:

> Well, with Dec NG futures contract from prev session @ $5.935 and
> UNG NAV @ 11.81, the new ration sems to be 1/9898, much worse than
> I expected.
>
> HardToLove

Oct 21 09:09 AM