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UNG arbitrage important rule reminder - by Matt H.

|Includes: The United States Natural Gas ETF, LP (UNG)

Is arrived to me a message from Matt, a reader of Seeking Alpha that was so nice to remember us the rule to short correctly UNG the etf we are hedging with the october future. And I remember that Monday we will switch to november futures day by day till 17th september as UNG fund will do.

Here his message about how to calculate the correct number of shares to short in UNG, because he noted I did some mistake in my first days that I corrected some day after when I noticed from my profit/loss records that I was not doing exactly the profits or losses I had to do with the quantities I used, SO you you read your collegue:

Danny,

I've been following your posts on seekingalpha and I agree with your hypothesis that the UNG /Prompt Month Nat Gas spread should narrow.

However, I'm concerned with what I'm seeing in your August 27, 2009 post.  It appears you went long an October Mini and short an equal dollar amount of UNG.  While on the surface this seems logical, I believe you haven't set up the arbitrage correctly and are exposing yourself to natural gas price risk.  Because UNG is trading at a premium you can't simply short an equal dollar amount of UNG.  You actually need to short the number of shares where the NAV is equal to the amount of natural gas.  This enables you to capture the premium without exposing yourself to gas prices (in that post you were effectively long natural gas).

For instance, here's how I am positioned today utilizing QG Oct2009.

Long 1 QG Oct 2009 @ 8250.00 (NYSEARCA:USD)

Short 814 UNG

Here is my reasoning.

UNG NAV = 10.03 (as of yesterday)
Today's % Change in Gas - 1.01%
Today's NAV = 10.1303

Number of UNG units to short = Price of gas contract / NAV of UNG

Thus, 8250/10.1303 = 814.3 shares short

In this way, your gas in completely hedged and you are not affected by positive or negative movements.  Regardless of movements in gas, if UNG premium goes to 0% today you will net about $916

With yesterday's big price change in gas the value of your current position will have outperformed the proper arbitrage because you are net long gas.  Had gas swung 15% to the downside, your current position would under perform.

I just wanted to bring that to your attention.  Let me know your thoughts.

Regards,

Matt H.


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A thank you too Matt, he can save some money to you, if you did some mistake, that is a classic on spreads and arbitrages like this.
 
See you next post.