Crude Oil/Nat Gas Spread: Aggressive Recovery Strategy

This Energy Spread Tanked

The blog entered a long position in the December crude oil/natural gas (x2) spread at -$17,000 (premium nat gas) on July 22nd and exited at -$22,410 (premium nat gas) on August 3rd after spending  five consecutive days below -$20k.

Broken Spread Pattern

We initially bought the spread because it has exhibited a pattern of making sizable recoveries after closes below -$17k.  This pattern may now be broken since the spread has been below -$17k for two consecutive weeks.

Now that the -$17k level has been broken, it turns into an overhead resistance level.  A great analogy that Peter Brandt uses is that of being out on a frozen lake.  When you are on the lake, the ice acts as support.  But if you fall through, the ice is suddenly a resistance barrier that you must get back above.

December Crude Oil Natural Gas (x2) spread daily

December Crude Oil Natural Gas (x2) spread daily

In the event that the December crude oil/natural gas (x2) spread can climb out of the water and get back above the “ice” at –$17k, it might make sense to get long again.  In addition, a close back above –$17k could indicate that the breakdown was a trap.

The Ratio

Now here’s a twist: While the spread broke down, the ratio may be establishing a double bottom.  This means that the fat lady hasn’t sung yet.

December Crude Oil Natural Gas ratio daily

December Crude Oil Natural Gas ratio daily

The December crude/nat gas ratio closed at a contract low of 12.95:1 on January 20th and rallied to nearly 18:1 by mid-May.  It closed at 13.1:1 on August 2nd and is starting to bounce again.  This has the potential to be a double bottom right around the Lucky Thirteen mark.

Power Play

Here’s an aggressive way to play the current setup.

First, go long in the spread right here and risk a break below the double bottom on the ratio chart.

Second, add another spread on a close back above the “ice level” at -$17k.  This would also place the December crude oil/natural gas (x2) spread closes above the declining 30-day Moving Average for the first time since early June.

Third, add a third position once the December crude oil/natural gas (x2) spread closes above –$14k.  At that point, the spread would be above last month’s high and the first two purchases would have nice open profits.

Trade Strategy:

Place a hypothetical order to buy one December 1,000 barrel crude oil contract and simultaneously sell two December 10,000 MMBtu (million British thermal units) natural gas contracts at -$20,000 (premium nat gas) or better.  Exit if the December crude/nat gas ratio makes a two-day close below 12.5:1.

  First ‘Add-On’ Trade Strategy:

Place a hypothetical ‘add-on’ order to buy one December 1,000 barrel crude oil contract and simultaneously sell two December 10,000 MMBtu (million British thermal units) natural gas contracts on a close above -$17,000 (premium nat gas).  Initially, this ‘add-on’ spread will be liquidated on a two-day close below -$20,000.

 Second ‘Add-On’ Trade Strategy:

Place a hypothetical ‘add-on’ order to buy one December 1,000 barrel crude oil contract and simultaneously sell 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.

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