Friday, November 2, 2012

UNG: Gas doesn't float

The United States Natural Gas Fund (UNG), an exchange-traded fund that tracks natural gas prices, gapped down below its 20-day low at the open on Friday, triggering a bear signal under my trading rules.

UNG has a very poor correlation with the S&P 500 -- only 7% -- so I like it for the diversification it brings to my holdings. Even so, today's market stories are linking the UNG fall with the broader market, so go figure.

The fund is prone to dramatic reversals on occasion, and it also tends to hold to a trend for awhile once it has begun. Volatility and persistence, of course, are the meat and potatoes of a trend follower.

UNG began its present uptrend in April from a low of $14.25 and began its most recent leg up from a low of $17.69 on Aug. 28. The movement carried the fund to a swing high of $23.38, just a cent above the 55-day high, on Oct. 19. That breakout immediately reversed and eight days carried the price down to its present bear state.

The near-term low in the zig-zag up was $21.47, and today's opening of $21.30 fell below that, marking a lower low and putting UNG into a downtrend using traditional support and resistance analysis.

UNG on average trades 7.8 million shares a today and supports a wide selection of option strike prices with four-figure open interest and a 1.3% bid/ask spread for front month at-the-money puts.

Implied volatility stands at 38%, near the bottom of the six-month range. Volatility has been rising, albeit slowly, since Oct. 22.

Options are pricing in confidence that 68.2% of trades will fall between $18.56 and $23.19 over the next month, for a potential 11% gain or loss, and between $19.76 and $21.99 over the next week, for a 5% gain or loss.

Options are trading 15% above their five-day average volume, with calls leading at 19% above average, compared to 11% above average for puts.

Today's fair-price zone on the 30-minute chart runs from $20.99 to $21.43, encompassing 68.2% of transactions surrounding the most-trade dprice, $21.35. The stock is trading below the zone with a bit more than two hours to go before the close.

My entry point was $21.39, and the first point to add to the position was below $21.07, which the price hit less than three hours after the breakout. So whatever is happening with UNG, it's happening in a big way.

Decision for my account: I took the trade, structuring the initial position as a bear call spread, short the December $22 call and long the $23 for a $32 premium per contract. This places the breakeven point at $39.75, near the initial stop/loss of $39.73. The return on risk is 47%.

Of course, I don't set a stop/loss on spreads. The maximum loss point, $38.99 in this case, serves that function.

After the tripwire for adding to the position was sprung, I structured the addition as long April $25 put options with a delta of 70. The stop/loss for the long puts is a trailing stop placed at double the average daily trading range (called "N" in my rules and in the Turtle Trading system) from the entry point.

The way my system works, if UNG reverses then my stop/loss on the long options will be triggered, causing the shares to be sold, and the initial short vertical spread will stay on my account until it expires in December (or until I close it a week before expiration).

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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