Picking a Bottom…Or Catching a Falling Knife
Today the blog entered a long position in the December crude oil/natural gas (x2) spread at -$17,000 (premium nat gas). We’ll exit on a five-day close below -$20,000.
Usually, we don’t like to buy a spread when it’s plummeting. The reason we took the chance on this one, however, is because it seems to find a bid down at these levels. The spread finished at -$17,690 today. As we noted before, the December crude oil/natural gas (x2) spread just hasn’t been able to stay below -$17k for more than a day or two over the last couple of years. It’s been like trying to hold a helium balloon underwater. So if you want to try picking bottoms, this is certainly the place to do it.
Pressing Our Luck
We also mentioned in the previous post that the last three drops below -$17k were followed by rebounds of nearly $16,000, approximately $13,500, and $13,300 over the following months. So we’re looking for a sizable bounce to start soon. Therefore, we would like to quickly add to the position if the spread does start to recover.
So far this month, the small bounces in the December crude oil/natural gas (x2) spread have ended either side of -$14,500. Prior drops below -$14k have only lasted four weeks at the most. Anybody who bought the spread at -$14k or lower and held on never had to wait for more than a month before the position was profitable.
Since the spread has already been below -$14k for just over three weeks, we can use a close back above this level as a signal that the bottom is in. Furthermore, a close above -$14k would mean that the position we entered at -$17k is already showing an open profit. This would allow us the cushion we need to add to the trade.
‘Add-On’ Trade Strategy:
For tracking purposes, the blog will make a hypothetical ‘add-on’ trade by buying one December 1,000 barrel crude oil contract and simultaneously selling two December 10,000 MMBtu (million British thermal units) natural gas contracts on a close above -$14,000 (premium nat gas). Initially, this ‘add-on’ spread will be liquidated on a two-day close below -$17,000.