UNG: Closing Out The Fall Bear Trade

Nov. 8.12 | About: The United (UNG)

United States Natural Gas Fund (SYMBOL: UNG) is getting ready to roll into the January 2013 futures contract and it is time to close out the fall bear trade established back in May.

The original trade was entering into a 1:3 call ratio in the $19-22 strikes (October Expiry) for a net credit of $2.24 while purchasing October $17 puts for $1.66 that produced an overall net credit of $0.58.

As of the 10/19/2012 close, UNG closed at $23.09 and has not closed higher since and finished at $21.22 as of 11/6/2012 close.

The original trade at expiration would have gotten an investor short 200 shares of UNG for every trade down at $22 and had $3.58 in net profits booked (net credit plus the $3 in profits from the $19-22 call spread). By closing out of the short shares the investor can book $0.78 in profits per share on top of the $1.79 in net profits per share for a total return of $2.57 per share or 11.68% return in less than six months.

The reason for closing out of the trade and taking profits is due to the potential for natural gas to rally going into winter and that taking profits is the easiest and lowest risk trade for the position.

Fundamentally, natural gas has pulled back from its high point by over 8% and should see a visit to the $3.90-$4.00 area on the prompt contract with normal weather this winter. An extremely cold winter would allow a prompt contract to at least see $4.25 if not higher.

The one pitfall of exiting the trade is if the winter will be warmer than normal and gas in storage continues to remain elevated which would depress any potential price gains. However, once more time has passed and the remainder of winter temperatures is better known then a trader could look at getting bearish again.

Just a snapshot of the decay in United States Natural Gas Fund since 5/18/2012 looks like this.

On 5/18/2012 July Natural Gas futures were at $2.822 and on 11/6/2012 December Natural Gas futures were at $3.617 or a rise of 28.17%.

On 5/18/2012 United States Natural Gas Fund NAV was at $19.64 and on 11/6/2012 the NAV was at $21.29 for a total rise of 8.4%.

This simple illustration shows that decay from contango rolls continue to drag down this ETF as has been discussed for years now and in less than six months eliminated 19.77% of potential price gains.

Disclosure: I am long UNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Overall net bullish deltas on UNG positions