Growfast's  Instablog

Growfast
Send Message
Stock, Options, ETF and Commodities Investor; My educational background is in Computer Science and Accounting with significant entrepreneurial and Fortune 100 Corporate experience in Information Management and Technology services in industries including: Consulting, Oil and Gas, Manufacturing,... More
  • DGAZ Risk Analysis 24 comments
    Feb 1, 2014 1:47 PM | about stocks: UGAZ, DGAZ

    Yesterday I wrote an article on my DGAZ Investment thesis. In follow up, this article will focus on more exploration and analysis on the risk and opportunity associated with investment in DGAZ. First, it should be noted that leveraged ETF funds carry a high degree of risk and volatility and are not for all investors. 3X leveraged funds can move substantially in a short period of time, which means investors can lose capital or make gains very rapidly.

    Lets first explore some assumptions associated with my investment thesis. As with any thesis, if assumptions turn out not to be true, then a thesis can fail or a model can turn out to be invalid. I will work on this analysis using past performance patterns as the best indicative view of how performance could play out in the future if these assumptions turn out to be true.

    1) Past performance patterns associated with UGAZ/DGAZ behavior will be indicative of future performance patterns.

    2) Natural Gas prices within the next 3 months will revert to the target range of 3.4 to 3.8/mmbtu.

    3) Winter severe weather has mostly passed and temperatures on average should continue to moderate during the next few months.

    Starting with the 2nd assumption, lets look at Natural Gas prices.

    Considering the known proliferation of available NG reserves in US shale zones, my assumption is that we will return to the range bound by the blue horizontal lines on the chart above, between 3.4 and 3.8/mmbtu. The pricing we see at present is based on price spikes associated with peak demand from severe winter storms we have had the past few weeks across the US.

    Exploring assumption 3, this is where we have risk and must dynamically watch for any signs of more severe winter storms. With the threat of any storms, it is recommended that one manage this risk, either with options, positions aligned to long Natural Gas (UGAZ or other alternatives) and/or, sell out of some or all of DGAZ positions and re-enter at lower prices in DGAZ. Traders can also adjust based on trading patterns when new resistance levels are hit, there can be a bullish run to allow for pricing adjustment by exiting some positions in DGAZ at the resistance level and re-entering near the end of the bullish push. My anticipation is this opportunity will be in movements of around .4 points in NG. Unless there is a compelling event, I don't anticipate bullish runs from here of greater than .4 points from any resistance hit at key support levels.

    Now, lets take a look at Assumption 1. First, I'll include the chart for DGAZ, with UGAZ overlaid for comparison.(click to enlarge)

    Vertical black lines are drawn for the prior cycle of the spread for UGAZ and DGAZ from beginning to end, as well as for the beginning of this current spread and my current assumption on the peak spread (although with another price spike, it would be possible to make new highs in UGAZ and new lows in DGAZ). It is my belief at this time, that we have seen the high, but investors should continue to watch for and manage risk in positions associated with risk of another compelling event.

    Below is a table of prices on DGAZ, UGAZ, NG and the NG Index at the dates of the vertical lines. Lets start with the first complete spread early this year.

    Pricing at inflection points - Spread Cycle 1
    Date DGAZ UGAZ NG/mmbtu NG Index
    2/15 22.45 17.19 3.153 54.85
    5/1 8.93 36.72 4.025 72.24
    8/9 18.82 14.04 3.22 52.99

    Price movement behavior from 2/15 to 5/1 max spread:

    DGAZ - (60%) UGAZ - 213% NG 27% NGI - 31%

    Price movement behavior from the 5/1 spread to the crossover on 8/9:

    DGAZ - 210% UGAZ - (38.2%) NG - (20%) NGI - (26.7%)

    Pricing at Inflextion Points - Current Spread (with Estimates)
    Date DGAZ UGAZ NG/mmbtu NG Index
    11/4 17.32 12.34 3.43 52.68
    1/29 * 3.29 41.28 5.449 83.28
    4/29 ** 11-12 est. 10 est. 3.6 est. 50 est.

    * - Assumes that we hit the peak spread of UGAZ and DGAZ on 1/29 and that we will not have another compelling event that drives a new high in UGAZ or, new low in DGAZ. Note that due to slippage in DGAZ in price spikes in NG, it is possible a rally not setting a new high could still drive a new low in DGAZ.

    ** - Estimates based on my charting and analysis, as well as applying price performance characteristics in line with prior spread cycle.

    Price movement behavior from 11/4 to 1/29 * (assumed max spread):

    DGAZ - (81%) UGAZ - 335% NG 59% NGI - 58%

    Price movement behavior from the 1/29 spread to estimated crossover around 4/29

    DGAZ - 335% UGAZ - (76%) NG - (34%) NGI - (40%)

    Natural Gas Index Chart UGAZ and DGAZ are predicated upon:

    Some conclusions from this analysis:

    1) If there are price spikes that drive NG prices and UGAZ to new highs (and DGAZ to new lows), the % increase in UGAZ (from the beginning of the spread cycle) would correlate fairly closely to the % move up anticipated in DGAZ. This would increase from the 335% estimate now. However, this demonstrates what Robert Edwards has been saying. If NG goes to $6/mmbtu, UGAZ goes to new highs and DGAZ to new lows, the % increase expected in DGAZ would go higher, but from a lower price. A 500% increase from a DGAZ low of $1, would give us a high of only $5. So, key to our modeling for 3x ETF leveraged performance is, we have to position our lows and our cost basis carefully!

    2) As a result of 1, investors should be prepared to reposition at key support levels and be prepared to exit DGAZ positions if dynamics lead to a belief there will be other significant upwards move, and/or, should hedge position risk appropriately with offsetting UGAZ, options or other positions.

    3) If we have seen the top in NG and UGAZ, as well as the bottom in DGAZ, then investors with the right cost basis have some nice upside ahead. However, these positions clearly need to be "managed positions". With the volatility in NG and other commodity prices, these positions are not conducive to buy and hold investing. Investors must either manage very small positions (for managing portfolio risk), or actively manage their position risk.

    Happy learning and investing and cheers to profitable investment on the UGAZ/DGAZ spread here in 2014.

    Disclosure: I am long DGAZ.

    Additional disclosure: I may trade and reposition DGAZ shares based on dynamics associated with the Natural Gas Market. I may also trade in and out of UGAZ, or buy/sell calls and puts on BOIL or KOLD (2X Leveraged ETFs on Natural Gas Index).The thoughts and opinions in this article, along with all stock talk posts made by the Author, are my own and are shared on the basis of helping others learn, to provoke other points of view that help us all on our journey to become better investors. My posts are never intended to provide investment advice. Investors should always view multiple sources of information in their due diligence process.

    Stocks: UGAZ, DGAZ
Back To Growfast's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (24)
Track new comments
  • Robert Edwards
    , contributor
    Comments (587) | Send Message
     
    Grow, excellent article as usual. I believe that now you have developed a comprehensive model that takes into consideration the risks involved and provides some ideas on how to manage that risk effectively. Now it will be a matter of timing to see if the top in NG prices is in, or we have another higher high spike to deal with. Hopefully it is the former. We will be monitoring prices very closely to see if support and/or resistance levels are violated.
    1 Feb 2014, 02:55 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Thanks for pushing the issue, RE. I really wanted to get to the bottom of this and the usual daily close calculation on slippage just didn't capture the performance characteristics for me. Studying the curves and price performance, helped me find the performance pattern that clearly indicates the relative performance characteristics between inverse ETF's like UGAZ and DGAZ. It is nice to have this understanding clear from the modeling and I would not have gone through the exercise to really get this if you hadn't pushed your view that drove me to more thinking and deeper analysis to not only understand it, but to help others learn it more clearly too.
    1 Feb 2014, 04:39 PM Reply Like
  • glaserdx
    , contributor
    Comments (274) | Send Message
     
    Grow- thank you for the multiple analyses you have written and the willingness to make revisions based on positive feedback. Actually thanks to R.E. and you both for the give and take which clarifies issues and offers a great learning experience to all.

     

    Just thought I would bring attention to what I believe are some typos in the percent changes i.e. UGAZ 2/15 of 17.19 to 5/1 36.72 is 113%; DGAZ 5/1 of 8.93 to 8/9 of 18.82 is 110%.

     

    That said, I looked at a 2 yr. UGAZ chart and would be hard pressed to argue with your $41 peak for this cycle, barring, as you said, any unseen events.

     

    I will need to manage an entry point with care. Thanks again.
    1 Feb 2014, 05:09 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Glaser - Thanks for pointing out the correct percentages. I should have done these tables in a spreadsheet to auto-calculate. But, glad you can derive value from this as hopefully it demonstrates the key characteristics in performance of these ETF's.
    1 Feb 2014, 07:23 PM Reply Like
  • Robert Edwards
    , contributor
    Comments (587) | Send Message
     
    Glaser is very helpful by catching my numerous mistakes, which I appreciate so I can make the corrections right away. Everyone needs someone like Glaser looking over their shoulder. He will send me a private email so it does not stick around permanently. Even now you can make the corrections and then delete Glaser's comment and no one will know. You can delete this comment as well.
    1 Feb 2014, 09:57 PM Reply Like
  • rxraider
    , contributor
    Comments (35) | Send Message
     
    Great analysis. It would be nice if these levered ETF's didn't 'slip'. I started building a position in DGAZ on Thursday morning at $3.61. Thought it would drop so I could pick up more, but it didn't. Will pick up more shares on a dip.
    1 Feb 2014, 10:38 PM Reply Like
  • glaserdx
    , contributor
    Comments (274) | Send Message
     
    Grow
    I re-read your article for the third time and in my opinion it gets better each time. It is a comprehensive overview of the risk/reward dynamics of investing in the DGAZ and UGAZ 3X ETFS.
    2 Feb 2014, 03:39 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Got another article to publish here in a bit that takes this even further. Will publish soon and really appreciate all the feedback and input that helps move this forward in the progression.
    2 Feb 2014, 04:30 PM Reply Like
  • User 14469782
    , contributor
    Comment (1) | Send Message
     
    you said you are Long in DGAZ . What will be your stop loss in it? Do you think NG can go to $6?
    2 Feb 2014, 08:42 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » I'm not at present using a stop loss, rather watching NG pricing, market dynamic news and DGAZ daily, especially at this point in the cycle.
    I don't think based on what I know today that NG prices will go to $6, but I definitely think they could. If we suddenly have another National Severe Winter Storm that will drive more record cold across much of the US, make another major draw on storage, I could see us with a spike up near $6. And, DGAZ would be at risk of severe deterioration even from current levels. With this kind of event projected, I would be quick to sell out of a good % of the position and look to buy back in at lower prices.
    Because by then the risk would be I would be selling shares after some news, they would probably already fall, I am considering buying some calls or puts against BOIL or KOLD that would profit in the event NG goes higher/DGAZ moves lower in order to manage that risk.
    3 Feb 2014, 09:04 AM Reply Like
  • rxraider
    , contributor
    Comments (35) | Send Message
     
    Call me crazy, but I'll add to my DGAZ position soon when it drops below $4.
    3 Feb 2014, 09:05 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Raider, looks like you will have your chance today. I may do the same....
    4 Feb 2014, 09:12 AM Reply Like
  • rxraider
    , contributor
    Comments (35) | Send Message
     
    DGAZ all the way down to $3 (down 27%). Think I'll go ahead and add some at this level. Yep, I'm crazy. What are your thoughts, Grow?
    4 Feb 2014, 01:36 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » I'm thinking of adding some here too. And, if we get near $6 NG, I'll get some more. On the other side of this spike, I would expect to see some free falling in the NG price. Should be looking at another one of those 30%+ days for DGAZ.
    4 Feb 2014, 01:41 PM Reply Like
  • rxraider
    , contributor
    Comments (35) | Send Message
     
    Added at $2.99, so my average is $3.30 at this point. We'll see NG inventories Thursday or Friday. Thanks for the info. Glad I'm not the only contrarian here.
    4 Feb 2014, 01:48 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Added more at 3.06 here. Looks like bulls starting to take profits or, at least a breather.
    4 Feb 2014, 01:54 PM Reply Like
  • wallstreet_gunslinger
    , contributor
    Comments (34) | Send Message
     
    Growfast, thank you for sharing your thoughts. How should one analyze time decay DGAZ in particular?
    5 Feb 2014, 02:14 AM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Wallstreet - Good question. I am not a quest to discover if there are good modeling tools for ETF's, similar to the tools available for options that helps view the performance curves and beta loss on them.

     

    In the meantime, it is a challenge to analyze, but the formula is known for looking backwards over the fluctuations in ETF pricing. Seems to me the key, prior to having good analysis tools on ETF's, is to monitor the slippage and decay, finding opportunity to re-position cost basis at regular intervals, especially when trends go against a trader while looking for a turn.

     

    If you read the next article in my series, DGAZ and Leveraged ETF Performance Analysis, you will see how slippage and decay concerns can become a moot point if the trend works with you - however, a trader must know that this same powerful force can work against one and sometimes the answer is just to get out until the time is right.

     

    As stated too, these are positions to "manage", more like options. Adjustments opportunities should be looked for along the journey.
    5 Feb 2014, 08:14 AM Reply Like
  • Paul u
    , contributor
    Comments (4) | Send Message
     
    Hi And thank you for your thoughtful and well done article. I am a new trader and unfortunately got into to dgaz way too early (above $10 initially) but have averaged down here. My main concern is that a lot has been written rencently that suggest due to low production due to wellhead freezing in Marcellus and other places, nat gas prices might nit drop below $4 for the foreseeable future. If that's true, I wonder what DGAZ max price might then be.
    Thank you
    7 Feb 2014, 09:24 AM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Good points and question. View my latest article from last night and see if this will help shed some light. Make sure anything you read boils it down to facts. The bulls are going to prey on emotion, if and when they can to drive any rally they can.

     

    http://bit.ly/1bfPTKM
    7 Feb 2014, 10:29 AM Reply Like
  • Paul u
    , contributor
    Comments (4) | Send Message
     
    Thank you Grow, that article was also excellent. Just one more question, what is your best guess regarding general time frame? Do you think it will be hit before May 2014?
    8 Feb 2014, 12:04 PM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » Paul, my theory at present is we will see a continuing trend downwards in Natural Gas prices going into April. I'm estimating at this point that by April/May (barring any significant changes in the Natural Gas market), we will see a high in DGAZ. I'm looking for the crossover of DGAZ vs UGAZ as being the end of the bullish trade(s) associated with DGAZ for the near future. At that point, I would regroup and re-evaluate what to do going forward, or when to look for another opportunity around Natural Gas.

     

    At some point during the summer or fall, I may be looking to go to positions long on Natural Gas as I believe the longer-term fundamentals will begin to look higher. If production ramps in a huge way though and we go into winter with Storage at 5 year averages, then we may have to wait longer for strong bullish fundamentals. We have to keep watching, studying and learning along the trail. A very hot summer could also affect the prices on NG.
    8 Feb 2014, 01:23 PM Reply Like
  • kmoorhouse
    , contributor
    Comments (2) | Send Message
     
    Good analysis. I too am long DGAZ and have been grabbing as much as I am able to in the $3 range. I am interested, what is your angle if they reverse split DGAZ like KOLD did when it went too low? Just curious if you will still be long DGAZ if they reverse split? thanks
    12 Feb 2014, 08:19 AM Reply Like
  • Growfast
    , contributor
    Comments (294) | Send Message
     
    Author’s reply » A reverse split would change nothing but the current price. The bullish chart and fundamentals along with my assumptions would still suggest we have room to run a good bit higher. Psychologically, it may even make the price action better, as trading something at 20.00 that moves 10% seems to show the move more than something trading at 4 that moves to 4.40. The smaller numbers for some might temper the view of what that % return really is by comparison.
    12 Feb 2014, 08:57 AM Reply Like
Full index of posts »
Latest Followers

StockTalks

More »

Latest Comments


Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.