How to Trade UNG Safely with Options

• stevenplace
• September 16th, 2009

I’ve seen plenty of traders out there try to “nail the bottom” as it were on natural gas, through swing trading UNG. This was a tough trade, due to the countertrend nature of both the commodity and etf– and there were a lot of larger players in the Long Oil short Natty trade.

So last week we started to see the name very oversold, with plenty of people (including myself) railing against the etf. A *lot* of fear came into the market, and the premiums (extrinsic value) in the contracts for UNG started to spike. You can see that in this volatility chart:

You can see that in the course of a couple weeks the premium (yellow line) started to significantly distance itself from the historical volatility we’ve seen over the past 30 days. When we pick up a distance like that, it tells me that volatility is a sell.

So we were looking to sell volatility. Well, that means selling options– but I don’t want to have unlimited risk, so we sold put verticals, getting us into a bull put spread. You can see the full trade here – it’s the second one down, in between the bullish calls on FCX and XME. We sold the Oct UNG 9/7 Put Vertical for .60 cents. In our model portfolio, we sold 3 of them, giving us a full credit of 180, with a total risk of 420.

Well UNG did bottom out– but we weren’t necessarily playing direction! Our trade was on the basis that UNG would not go down as fast as what the options were pricing in.

We recently closed out the position by buying the vertical back for .15. That’s a total profit of 135, or 32% return on basis.

I will be looking to reenter this trade if we get another spike like that in UNG. Currently, bull put spreads are the best way to play the name.

If you like these kinds of trades, subscribe to my options trading service. We’re building out our book and making some serious profits.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: fcx, ung, xme

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