By Beacon Energy's Stephen Kessler

Enjoy this week's insights into the North American natural gas market sent to you compliments of ICE. With over 25 years’ experience in derivatives, Beacon Energy's Stephen Kessler shares analysis on market movements as well as his own trade insights.

Stephen Kessler
Natural Gas Broker, Beacon Energy Group

Kessler has been brokering at Beacon Energy Group since 2010, putting out commentary on natural gas market movements as well as his own trade insights. Kessler has more than 25 years’ experience within the derivatives markets, and prior to his role at Beacon, he was trading natural gas and soft commodity options both independently as a market maker and with a hedge fund.

If you’re interested in a more in depth look or wish to provide feedback, connect with Stephen Kessler.

Connect on LinkedIn

NOVEMBER 22, 2017 

  • This past week Z saw a painfully slow deterioration from $3.10 to testing prices under $3.00 this morning. Given that tight range it is no surprise vol took it on the chin. Given the steepness of the Q1 put skew the market is still not pricing in any fear of a near term collapse. That is either because we are too early in the season to write the upside off for good, or complacency given how well that strategy worked all summer. I think it is too early to write off upside potential, but I am of the opinion if weather does not pan out and production continues robustly that there are prices in play to the downside we have not seen in over a year.
  • Vol in Q1 suffered greatly since the middle of last week - 3ish vols plus theta - and at these vols do not underestimate the cost of a week of bleeding. There is either a dismissal already of any potential upside fireworks, or the market is saying any rally will be orderly and capped at fairly modest prices. Either way it does not seem to jibe with the fact that the 375 area in G and H seem to be the most skewed options on a relative basis - compared to other calls. It is a point I address later in the commentary.
  • JV8 vol saw some selling pressure this week. As Q1 gets hit I think any winter risk premium the market adds to Q2 in particular will ebb out (especially in J18) and while that vol is not massively overpriced in my opinion but still has room to compress further. Call skews are now noticeably (and in my opinion justifiably) negative, I have talked for many weeks about how expensive the JV8 $3.50 calls looked relative to the $2.50 puts and that is starting to move. I also think Q2 2018 vol is relatively expensive as compared to QV 2018 vol (especially in puts). Not much in the summer looks particularly cheap to me but as I mentioned the front end looks the most expensive.
  • I am leaving in the portion about JV8 vs. JV9 skews because they have not materially changed and neither has my opinion on them. In comparing skews in JV8 and JV9 it is interesting that the $1.00 wide fence (2.50/3.50 in JV8 and 2.25/3.25 in JV9) trade at a similar vol differential put to call. Given that JV9 vols are so much lower than JV8 I take this to mean one of 3 things - JV8 downside risks are perceived to be much less than JV9, JV8 upside risks are perceived to be more significant than JV9, or something is mispriced. I cannot make the argument that JV8 has significant upside risk at this point given the market is now pounding calls in the $3.50 area so it is one of the other two. In my opinion it is actually a combination of the other two - the market does not perceive significant downside risks in JV8 - some of that may be a leftover hangover from this past summer when every dip brought on put selling and a market floor existed. But I also believe there is opportunity here in two places on the curve - I do not think the $2.50/$3.50 fence in JV8 reflects the relative vols that will be achieved if we go up or down .30 in that strip. Secondly, instead of the entirety of JV9 I would focus on J9 - the calls there trade with essentially no skew (and arguably negative skew at times). It is a little early but at some point the funds will move to buy Q1 2019 calls - it is a pattern understandably repeated before every winter. When that happens I strongly believe the J9 calls will find buying and get dragged higher in vol and call skew alongside the H9.
  • Given the selloff and the JV8 vol weakness the late summer 2018 call vs J19 call has already moved. Since I have a short bias to JV18 I still like the trade but obviously not as aggressively. If H9/J9 gets under .35 I would wait to add or initiate a position like V18 375/ J19 350 c/s.
  • I talked for a few weeks about F being the point on the vol curve in the fronts that I thought was the “best” spot to sell vol - especially relative to H. Going back about 3 weeks to the beginning of the month the F 305/ H 305 straddle spread was approximately .195. This morning it is priced closer to .23-.235. At these vol levels I would take the vol spread off. Particularly because the implied vol of the F 275 put is low enough I consider it a buy vs. a similar put in G or H. Even against the J 2.50 put. If vol continues in I would expect it to be more of a 1:1 vol move in F/H given the F straddle is already approaching .30.
  • I still also think the shape of the skew misprices some calls in G and H. The skew in the $3.75 and $4.00 calls is significantly higher on a relative basis than calls above them. Comparing the vol differential between the $3.25 and $4.00 calls and then the $4.00 and $4.75 calls it is clear the skew starts to flatten in shape. I would argue that a move towards $4.00 is very bullish for vol, but (albeit an unlikely) move to $4.75 is a game changing move that would lead to far higher vols and chaos. This is not something I believe should go on ad infinitum - I am not advocating that the H $7.00 call should be .03 now, but up to the $5 area I think the skew should be a smooth curve or even steepen, not flatten. Given that I think structures like that the G and H 325/375/425 call fly are underpriced and good value hedged. Both slowly pick up ticks over time and have slight positive gamma.
  • The 3-ways I mentioned last week in Z and F have performed well - not so much as a directional play but the option premiums have imploded so much there was almost no way not to profit from any combination of one. Again at these current levels -especially in Z - I would take them off for a profit.
  • Lastly I hope everyone has a safe and happy Thanksgiving!

Stephen Kessler
Natural Gas Broker, Beacon Energy Group

Kessler has been brokering at Beacon Energy Group since 2010, putting out commentary on natural gas market movements as well as his own trade insights. Kessler has more than 25 years’ experience within the derivatives markets, and prior to his role at Beacon, he was trading natural gas and soft commodity options both independently as a market maker and with a hedge fund.

If you’re interested in a more in depth look or wish to provide feedback, connect with Stephen Kessler.

Connect on LinkedIn

NOVEMBER 22, 2017 

  • This past week Z saw a painfully slow deterioration from $3.10 to testing prices under $3.00 this morning. Given that tight range it is no surprise vol took it on the chin. Given the steepness of the Q1 put skew the market is still not pricing in any fear of a near term collapse. That is either because we are too early in the season to write the upside off for good, or complacency given how well that strategy worked all summer. I think it is too early to write off upside potential, but I am of the opinion if weather does not pan out and production continues robustly that there are prices in play to the downside we have not seen in over a year.
  • Vol in Q1 suffered greatly since the middle of last week - 3ish vols plus theta - and at these vols do not underestimate the cost of a week of bleeding. There is either a dismissal already of any potential upside fireworks, or the market is saying any rally will be orderly and capped at fairly modest prices. Either way it does not seem to jibe with the fact that the 375 area in G and H seem to be the most skewed options on a relative basis - compared to other calls. It is a point I address later in the commentary.
  • JV8 vol saw some selling pressure this week. As Q1 gets hit I think any winter risk premium the market adds to Q2 in particular will ebb out (especially in J18) and while that vol is not massively overpriced in my opinion but still has room to compress further. Call skews are now noticeably (and in my opinion justifiably) negative, I have talked for many weeks about how expensive the JV8 $3.50 calls looked relative to the $2.50 puts and that is starting to move. I also think Q2 2018 vol is relatively expensive as compared to QV 2018 vol (especially in puts). Not much in the summer looks particularly cheap to me but as I mentioned the front end looks the most expensive.
  • I am leaving in the portion about JV8 vs. JV9 skews because they have not materially changed and neither has my opinion on them. In comparing skews in JV8 and JV9 it is interesting that the $1.00 wide fence (2.50/3.50 in JV8 and 2.25/3.25 in JV9) trade at a similar vol differential put to call. Given that JV9 vols are so much lower than JV8 I take this to mean one of 3 things - JV8 downside risks are perceived to be much less than JV9, JV8 upside risks are perceived to be more significant than JV9, or something is mispriced. I cannot make the argument that JV8 has significant upside risk at this point given the market is now pounding calls in the $3.50 area so it is one of the other two. In my opinion it is actually a combination of the other two - the market does not perceive significant downside risks in JV8 - some of that may be a leftover hangover from this past summer when every dip brought on put selling and a market floor existed. But I also believe there is opportunity here in two places on the curve - I do not think the $2.50/$3.50 fence in JV8 reflects the relative vols that will be achieved if we go up or down .30 in that strip. Secondly, instead of the entirety of JV9 I would focus on J9 - the calls there trade with essentially no skew (and arguably negative skew at times). It is a little early but at some point the funds will move to buy Q1 2019 calls - it is a pattern understandably repeated before every winter. When that happens I strongly believe the J9 calls will find buying and get dragged higher in vol and call skew alongside the H9.
  • Given the selloff and the JV8 vol weakness the late summer 2018 call vs J19 call has already moved. Since I have a short bias to JV18 I still like the trade but obviously not as aggressively. If H9/J9 gets under .35 I would wait to add or initiate a position like V18 375/ J19 350 c/s.
  • I talked for a few weeks about F being the point on the vol curve in the fronts that I thought was the “best” spot to sell vol - especially relative to H. Going back about 3 weeks to the beginning of the month the F 305/ H 305 straddle spread was approximately .195. This morning it is priced closer to .23-.235. At these vol levels I would take the vol spread off. Particularly because the implied vol of the F 275 put is low enough I consider it a buy vs. a similar put in G or H. Even against the J 2.50 put. If vol continues in I would expect it to be more of a 1:1 vol move in F/H given the F straddle is already approaching .30.
  • I still also think the shape of the skew misprices some calls in G and H. The skew in the $3.75 and $4.00 calls is significantly higher on a relative basis than calls above them. Comparing the vol differential between the $3.25 and $4.00 calls and then the $4.00 and $4.75 calls it is clear the skew starts to flatten in shape. I would argue that a move towards $4.00 is very bullish for vol, but (albeit an unlikely) move to $4.75 is a game changing move that would lead to far higher vols and chaos. This is not something I believe should go on ad infinitum - I am not advocating that the H $7.00 call should be .03 now, but up to the $5 area I think the skew should be a smooth curve or even steepen, not flatten. Given that I think structures like that the G and H 325/375/425 call fly are underpriced and good value hedged. Both slowly pick up ticks over time and have slight positive gamma.
  • The 3-ways I mentioned last week in Z and F have performed well - not so much as a directional play but the option premiums have imploded so much there was almost no way not to profit from any combination of one. Again at these current levels -especially in Z - I would take them off for a profit.
  • Lastly I hope everyone has a safe and happy Thanksgiving!

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