One of the first lessons and instructions I was given back in 1979 when I entered the dealing room was that you never sell naked Option Premium. Why was that? “Option sellers eat like Sparrows and shit like Elephants”. Could have been put a little bit more politely but it meant I never forgot it. Over the years I’ve seen many a trader or fund blow up spectacularly by not following that rule.
One of the most popular and crowded trades for years has been long Crude/Short Nat Gas and its worked well most of the time. It has encouraged the selling of Crude puts and Selling of Nat Gas calls. A win win all round. That is until this week. I said in my last post on Crude on November 7th that Crude had hit its final downside target. Only the most aggressive could get long, noting that powerful resistances still lay above and that a weekly close below that price at $61.58 would leave no support at all. By Friday price had indeed made that close and yesterday collapsed in earnest. One of the catalysts has been the huge Put option positions that have built up in both Futures and the OTC market. On Futures even today there remains over 30,000 60 puts and the same number of 55 puts that expire today. This level is critical support just for this session.
Option Open Interest
As each major strike is breached on a closing basis it begets more selling by Option granters as they are forced to hedge up. What has compounded this selling into a crescendo yesterday, is the breakout higher in Natural Gas. The chart below is a daily continuation and shows how price has been subdued for years. Price finally gapped higher last week above the final blue line monthly resistance (circled) which meant that suddenly there wasn’t any barriers. Friday saw a PowwerPlay buy signal which indicates an expansion of trend and another has already appeared today. The players who have been long Crude / Short Gas on a Futures basis have seen there position blow up once again on the Nat Gas side before America has even opened.
Nat Gas Daily
So what Next? The first thing is to look at Open Interest and Nat Gas shows that it is close to its most elevated levels since 2013. This provides plenty more fuel for shorts to have to cover. Next resistance is distant at 6440.
It also worth putting what looks like a big rally into context. The monthly chart shows how small the rally actually is with 3 major spike of far greater magnitude in the early 2000,s.
Nat Gas Monthly
Moving forward it will be necessary to use the short term levels with volatility so high. Support is still distant but these levels will rise in the next day or two.
Nat Gas 15 Minute
For Crude, major levels on an intraday basis have moved to yesterday’s lows, but any breaking of that point will trigger further Option based top loss selling.
Crude 60 minute
The daily chart highlights the technical damage as there is no support until a monthly level all the way down at $41.30. Any major bounce will see it need to overcome a formidable zone between $61.58 and $65.74.
Winner of the Technical Analysis Book of the Year 2014, Mapping Your Voyage of Discovery, Shaun Downey is a veteran of the markets and a globally recognized name in the world of Technical Analysis. He began his career in 1979 at age 16 with Rudolf Wolff Commodity brokers. Initially, he specialized in Softs and Grains, then moved into the the oil market and eventually became head of FX hedging and market making. A switch to Fulton Prebon eighties saw him move into Bond trading and Options, followed by a move to Australia as Global Head of trading handling interest rate, commodity and currency risk. He has run various private funds and and traded all asset classes including individual stocks.
Shaun has been writing a a variety of technical analysis commentaries for the professional and retail market since 1991and mentors his customer base who use his unique methods, based on his first book Trading Time: New Methods in Technical Analysis published in 2006. He spent 20 years at CQG where he had the unique opportunity to learn, create and test all things technical and brings a wealth of experience having met thousands of traders in dealing rooms around the world.
Grandfathered member of the Society of Technical Analysts