Natural Gas Implied Volatility Spiking

By Bill Luby | July 22, 2008 | 1:30 PM | 1 Comment

Perhaps it is just a coincidence that the "Oil VIX" appeared on the scene just as the implied volatility in oil futures (or at least as captured by (AMEX: USO) was hitting an eight month high. The "Oil VIX" (formally known as the CBOE Crude Oil Volatility Index; ticker (OTCBB: OVX) and crude oil may get the lion's share of the energy headlines, but lately it has been natural gas that has been making the more dramatic moves.

A look at the three month chart of (AMEX: UNG) (the natural gas ETF that is the counterpart to USO), courtesy of the ISE, shows implied volatility steadily increasing over the past five weeks, with the gap between implied volatility and historical volatility continuing to widen - all while natural gas has pulled back about 27%.

Natural gas implied volatility levels are higher than oil implied volatility levels at the moment, and the pullback in natural gas presents some interesting trading opportunities. Some momentum players are already short here and some value hunters are buying on weakness, particularly if they believe in the long-term commodity bull and other supply and demand issues that are specific to natural gas-specific.

The case for natural gas trading sideways from current levels is hard to make. Directional bets are expensive, due to high IV. Two trades I am looking hard at, with a bullish directional bias, are bull put spreads and call backspreads. The former limits upside and downside; the latter is more aggressive and more risky.

 

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