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Trading Natural Gas: What Every Investor Should Know

written by: Tim Plaehn•edited by: Jason C. Chavis•updated: 7/17/2011

As one of the primary sources of energy, investors and traders like to have options to trade the changing value of natural gas. The different security markets offer several paths to trade natural gas. Using ETFs and the futures market, one can find an investment strategy to fit your trading goals.

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    The Other Energy Source

    Along with crude oil and coal, natural gas is a widely used energy source. Natural gas can provide in-home heating and also be used for generating electricity. As a marketable commodity, investors and traders may want to take a position in natural gas to profit from an expected rise or fall in the market price. Trading of natural gas derivative financial products is done to achieve one of several investment objectives.

    • Hedging protects a current financial position against an adverse price change. For example, a power company may buy natural gas futures to lock in current prices against a future price increase. Or an investor with a portfolio that includes natural gas production stocks may want to hedge against a declining natural gas price.
    • Speculation is the taking a position in a natural gas derivative product to profit from a changing price. Speculative positions can be established to profit from rising natural gas prices, declining prices or a flat price environment.

    Trading natural gas commodities can most readily be accomplished through the use of exchange traded funds -- ETF -- or natural gas futures contracts.

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    Exchange Traded Funds

    Natural Gas Flares The simplest method for most investors to take a position on the future value of natural gas is through the use of ETFs. Commodity ETFs use the futures of a specific commodity such as the price of natural gas, to track the value of commodity. As of 2011, there are an even half-dozen ETFs tracking the value of natural gas:

    • United States Natural Gas, stock symbol UNG
    • iPath Dow Jones-UBS Natural Gas Total Return ETN, symbol GAZ
    • United States 12 Months Natural Gas, symbol UNL
    • iPath Pure Beta Seasonal Natural Gas ETN, symbol DCNG
    • Teucrium Natural Gas Fund, symbol NAGS
    • ETRACS Natural Gas Futures Contango ETN, symbol GASZ

    Of the listed funds, UNG, GAZ, UNL and NAGS track the price of natural gas, rising and falling with the price of the energy source. UNG is by far the largest fund, but can suffer from contango issues since it only holds the near month contract. UNL may provide a more stable platform for taking a long term position in the price of gas. NAGS tracks natural gas without using futures, but the fund is still very small.

    The gas contango fund, GASZ launched in June 2011. The fund is designed to profit from the difference in contract prices between the one-month and one-year gas futures contracts. Time will tell if this strategy can produce profits for investors.

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    Futures Trading

    The other major avenue to trade natural gas is to trade futures contracts. To trade futures, you must open an account with a registered commodity futures broker. Futures trading allows traders to take leveraged positions in a particular commodity and the resulting gains or losses can be significant in relation to the required margin deposit per futures contract. There is a large number of natural gas futures contracts, each based on delivery dates and locations. Traders focus on the most active contracts, which are the Henry Hub natural gas futures, symbol NG, and the e-mini natural gas futures, symbol QG.

    Futures traders focus on the value of a "tick" or minimum price change per contract. For the NG futures contract each tick is 1/10 of a cent on the price of natural gas and for QG, a tick is 1/2 of a cent. In both contracts a tick change is worth $10. If the price of natural gas changes by 10 cents, the value of an NG contract will change by $1,000 and the QG contract will gain or lose $250.

    A futures trade can be opened in either direction: long or short positions. A long position profits from a rising gas value and a short position is taken if the price of gas is expected to decline. For each contract in a trade, a trader must have on deposit a minimum margin amount, which will be restricted in the trading account. Currently the initial margin deposit for a NG contract is $4,050 and a QG contract requires a deposit of $1,013.

    Natural gas futures contracts are available with monthly expirations for the upcoming year and annually out to five years. Traders focus on the near month contract where the majority of volume and pricing action occurs

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    Fundamentals

    A novice investor or trader might expect natural gas prices to move in tandem with crude oil. This is often not the case. Since the commodity bubble burst in 2008, the price of oil dropped and has risen again, topping $100 per barrel at times. The price of natural gas has not had that type of recovery.

    First, natural gas prices are more localized than crude oil. The cost of gas in the U.S. is significantly different than in Europe or other parts of the world. Also, gas prices can vary across the U.S. depending on where the gas is produced in relation to the markets where it is needed.

    Second, the U.S. produces the majority of the gas it consumes and in recent years gas producers have been able to significantly increase natural gas production with new wells and major gas discoveries.

    Trading natural gas using commodity based ETFs or futures contracts is best limited to attempting to generate profits from short term price changes for gas. Investors with a long term belief in the value of natural gas may be better served by selecting the stocks of gas production companies or an ETF which holds such stocks. This investment avenue will pay an investor dividends and the share prices will increase if gas does move to a long term uptrend in price.

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    References

    CME Group: Energy Products, http://www.cmegroup.com/trading/energy/

    ETFdb: Natural Gas ETF List, http://etfdb.com/type/commodity/energy/natural-gas/

    Image: sirdle on Flickr under CC BY-SA 2.0