This Jan 2022 update explains the hedging and ultimate exit for all our Natural Gas position in UNG ETF. The original trade was started in March 2021 approximately 10 months ago. Recall from our previous Nov 2021 update we had added option trade overlays that take advantage of the higher option volatility on the Natural Gas ETF (UNG). These all expired worthless, leaving the underlying ETF position and ITM call options.
Natural Gas Exit 2022 – Hedging
Hedged entire position on 1st Dec 2021 (around $14) with 100 contracts at $13 put into Jan 2022. This was important because it enabled the UNG position to be held with huge down move to around $12 throughout Dec 2021 with the ultimate recovery back up towards $16 in Jan 2022. Throughout most of Dec 2021 UNG was in a range of between $11 and $13 with little movement outside that relatively tight trading range. This month long trade range was usually given the previously directional trending UNG price for the last 6 months.
Although the $13 put Jan 2022 hedge was ultimately a money loser, it did enable the position to be hedged towards the end of the huge downdraft from $20 (Oct 2021) to $12 (Dec 2021). Ultimately enabling exiting with the overall UNG position with a profit in Jan 2022. Just because the hedge doesn’t make you money, doesn’t mean it is useless – the overall position of underlying, plus any hedges, is the main consideration.
Natural Gas Exit 2022 – Sell Longs
Sold majority of long exposure on Jan 12th 2022 in two main trades during a large price rally up to over $16. First selling the underlying ETF 5000 UNG at $15.35 in the morning. Second selling the 50 long ITM Call strike $11 Jan 2022 in the afternoon for $4.98 (with UNG at about $15.99). This gave an average share price exit of about $15.67 on Jan 12th. The deep ITM calls were due to expire the following week and were trading like stock (about 99 delta). Therefore it is appropriate to use their sale price (with the UNG ETF position as well) to calculate an average exit price for the overall position. Looking at the 5 day chart for the week 10th to 14th Jan 2022 shows that this trading ended up being some of the best pricing for the week.
The position was exited quickly (all on the same trading day) when the opportunity presented. This was because half of the position was in deep ITM calls that were going to very likely be assigned (with an $11 strike) on January option expiration on 21st Jan 2022. It is hard to time the exact top in a market that aggressively moving higher, but on this occasion it was traded well this week.
Natural Gas Exit 2022 – Spreads
After most of the long deltas were sold, still need to sell remaining spreads in final week of Jan 2022 expiration. To further complicate matters this was a short trading week with only 4 trading days from Tues to Friday (because Monday was a trading holiday). The positions held on 18th Jan 2022 at start of trading week were 1) a bull call spread long $16 and short $18 expiring 21st Jan 2022 and 2) a bear put spread long $13 and short $11 expiring 21st Jan 2022. These options were the last remaining UNG positions in spreads only, so was much lower risk that long deltas previously held. The expectation was that there would continue to volatility in the final expiration week and that would generate an outside move in either direction. To make some money on at least one of these spreads, then UNG had to move quickly in either direction and not stay in a range. As it happened the market crashed down and on 20th Jan 2022 at under $13 the $13/$11 bear put spread was taken off with some time value remaining to extract at least some value from the hedges (rather than zero by expiring worthless in a few days). The $16/$18 bull call spread was a full loser.
They was no obvious catalyst for an extreme move in either direction after option expiration on Jan 21st, because presumably this cold spell would be short lived. Therefore no new option positions were rolled or started. Additionally holding UNG long term is typically not a good long term multi year trade due to in built ETF decay, and this position has been held for about 4 months so far (which would likely include some ETF decay). Since there was no desire to maintain a UNG position into the rest of 2022, then all positions either expired or were taken off – leaving no open positions after 21st Jan 2022.
Natural Gas Exit 2022 – Future Idea
There was one potential strategy that wasn’t used at the time, but that could be useful in future. However this can usually only be considered when the call put skew is 2:1 on call side – as was the case in the large price spike into Oct 2021. Since the equivalent OTM call premium was twice that of the equivalent strike OTM put premium, then it was possible to sell 1 call and buy 2 puts for an even money collar. For example in Oct 2021 with UNG at $20, could have hedged with short 1 call Dec 2021 strike $24, but long 2 puts Dec 2021 at strike $18 – all for even money.
That gives an interesting risk profile:
If the market goes up a lot then that would still have given decent upside potentially, obviously capped out at the short call strike.
If the market stays in a range, then ultimately the 1 x short call and 2 x long put would lose value and ultimately expire worthless. With hindsight, this would be equivalent to holding the position without any hedges – but obviously risk management on larger positions is important to preserve capital – did not KNOW that this would be the case in advance.
If the market goes down a lot then importantly money could be made in an extreme crash – because the doubled up puts actually make the natural gas position to go net short the lower UNG prices goes. This works because even though the underlying UNG ETF position (with a delta of 100) is declining, having double the number of puts means their negative deltas can more than offset the underlying position. For example if UNG was at $15 then the deltas on the doubled up puts would be approximately 65 delta + 65 delta = – 130 delta. Since the UNG delta will always be 100 delta, the overall position would have a delta of 100 (underlying) minus 130 delta (double puts) – for a total of about negative 30 delta. This is what actually happened with a move down towards $12 in Dec 2021.
So with hindsight this 2:1 collar would have been a great strategy to participate in the upside and the downside. Especially when the Natural Gas market expectation was significantly higher prices in the next month (high OTM call premium), but where history shows huge crashes over a few trading sessions are possible (look at any multi year historical price chart). If this situation presents itself in future, then the 2:1 collar strategy is one we would definitely consider.
Natural Gas Exit 2022 – Summary
Using some hedges (such as the $13 put) allowed us to maintain the position during the dip down to nearly $12 (and lower) in Dec 2021. This would have been very poor risk management to maintain that size of position without a hedge, even though in the end would have made more money without the hedge. The ultimate exit was quite fortunate as were running out of time with Jan 21st 2022 option expiration less than 10 away. There was a huge futures price spike due to storm and cold spell that enabled a swift and profitable exit. However in Oct 2021 this could have executed or hedged at around $20, so this did “leave” about $4 of UNG “on the table” (or about $40k) with better trading. In summary made about 200% but could have made 500% with better trading.