– Natural gas option vol has been tricky lately to say the least
– Option Vol in equities and crude has fallen but in natural gas it remains elevated
– As shown in the chart below (May-June contract), except for the second week of March, realized/implied vol has not been performing but IV still remains elevated which leads us to believe that traders still expect a down move in the front of the curve
– As we pointed earlier, put skew went through the roof when front was in 1.80s and it got the direction right as natty tried to break and settle below $1.60 multiple times
– We believe the short covering we are witnessing (as evident in the CFTC report) is keeping the front from falling apart, but the option flow wants natural gas lower
– Skew is making moves that are unprecedented for the time of the year. May contract 10 delta skew (C – P) is -31%. We don’t remember seeing -15%, -20% call skew for that part of the curve ever.
– Total vol on those calls is 50%-55% and we are realizing over 60% right now (shown in above chart), so one can easily create some cheap gamma positions by doing ratio call spreads in the front
– Bullish action is reserved for the back part of the year and Q1’21 as seen in widening of spreads and interest in owning Q1 call spreads. Q1 vol and skew has found a short term peak as they got so expensive so fast that traders are shying away from buying them outright for now. Though, if Q1 ever gets super bullish on lower storage fills and/or production declines, those expensive outright calls are the ones that are going to pay the most still.
– This yin-yang chart below shows this bearish summer, bullish summer sentiment the best. 15% vol skew for October puts and 15% vol skew for January calls. We believe that the market can’t be extremely bearish and bullish 3 months apart and at some point soon, one of those will have to soften.
– Overall, the option action seems bearish the front. Puts are bid, calls are not. Sub $1.00 strikes have started trading for middle to late summer. Close to 20,000 October $1.60/$1.50 put spreads traded last two days. Sub $1.50 put flys are in great demand.
– As an options trade we are happy to own the -20% call strikes. Those will be more profitable on a down move than on an up move, cheap gamma plus potential for vol and skew to go higher.
Valor Analytics makes it easy to read the natural gas options tea leaves. Email us at email@example.com if you are interested in our paid commentary/trade ideas/analytics/data services. Subscribe below for the free blog.