How to trade rising natural gas prices and falling oil prices

Part 3
How to trade rising natural gas prices and falling oil prices (Part 3 of 6)

Must-know recommendation: Key ways to play the natural gas rally

Natural gas ETFs

The most straightforward way to play a rise in natural gas prices is to go long a natural gas ETF such as the United States Natural Gas Fund LP (UNG). UNG’s  stated objective is for its net asset value to reflect the changes of the price of Henry Hub natural gas as measured by its corresponding futures contract on the NYMEX. So the fund aims to directly track natural gas prices.

2014.01.16 - NG1 vs UNGEnlarge Graph

However, note that it’s possible for funds like UNG to systematically underperform the actual price change in natural gas. For example, the total return on UNG from November 1, 2013 (a price of $17.45), to January 14, 2014 (a price of $21.22), was 22%. During that same period, the front month natural gas contract increased from $3.51 per MMBtu to $4.37 per MMBtu, a rise of 25%. Natural gas ETFs tend to underperform the actual natural gas contract due to holding a portfolio of natural gas futures contracts that need to periodically roll over, incurring some trading costs and also losing money, as natural gas futures are often in contango. For more analysis on this trend, see How to invest in natural gas.

The pro of investing in natural gas ETFs is that they very highly correlate with movements in natural gas. Plus, investors can take a smaller position through natural gas ETFs than through directly trading in natural gas futures.

2014.01.16 - NG1 and ETF CorrelationEnlarge Graph

The major drawback is that the natural gas ETFs tend to systematically underperform natural gas prices due to having to roll the futures contracts they hold.

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