In September, the price of natural gas fluctuated more than we had seen since February of this year and it's likely that while some investors made vast sums of money, others lost just as much, if not more. But what made September so crazy was that natural gas made a significant reversal right in the middle of the month.
The price of the United State Natural Gas ETF (UNG) ended the month of August at $23.95 and closed at $24.83 on the last trading day of September. That move represents a 3.6% increase, not an insignificant amount but also not making anyone piles of money. But, while the price of natural gas started the month at $23.95, its lowest closing price for the month came on September 14, where it bottomed out at $22.69. Had you been watching the price, recognized this was the bottom and bought on September 14 or 15, you could have made yourself a nice 9.4% gain (the gain would be higher if you continued to hold for a few days at the beginning of October).
Again though, a 9% gain is a good return, but not necessarily what I would call “rolling in the dough.”
In order to make that kind of money, you would have had to use leverage. If you had purchased shares of the VelocityShares 3X Long Natural Gas ETN (UGAZ) at the close of September 14 and sold them at the close on September 28, you would have made a sweet profit of 30%. (Again, this would have been even larger, upwards of 50% if you held onto your UGAZ the first few days of October.)
Why did UGAZ perform so much better than UNG? Well, that is because UGAZ is three times leveraged natural gas fund, meaning it gives your three times the return of natural gas if the commodity moves higher. The flip side of that is you can lose three times the amount of money if natural gas prices fall while you hold the shares.
For those times when you think natural gas is going to fall you can buy shares of the VelocityShares 3X Inverse Natural Gas ETN (DGAZ). DAGZ is the three times leverage short for natural gas. This would have been nice to have been holding at the beginning of September when DGAZ went from a closing price of $21.47 on August 31 to the closing price of $25.09 on September 14, giving you a healthy 16.8% return.
But if you held on to DAGZ all month long, you would have ended September down 12%. Worse yet is if you had purchased DGAZ on September 14 and held until the end of the month, you would have taken a 25% haircut, (even more if you continued to hold it the first few days of October).
The ideal play here would have been if you bought DGAZ September 1, sold it on September 14 and rolled right into UGAZ that day. Then continued to hold UGAZ until the end of the month (or even longer). Had you traded this way in September, you would have finished the month up 46.8% (or well over 65% if you held the first two days of October).
I would love to sit here and tell you that trading in this manner is as easy as it is for me to explain, the fact of the matter is that we are all seeing the past with 20-20 vision, while the future is very unclear. Making matters worse is that when you are using leverage, especially 3X leverage when a trade turns on you, the losses compound very quickly. This point is made very clear when you consider that if you had held DGAZ all month, you would have only lost 12%, but if you only owned it from the 14 to the 28, you lost double that amount.
Timing is the most important thing when you are trying to trade. While it certainly would have affected your losses had you owned DGAZ, it also would have dramatically changed your gains if you held UGAZ. For example, UGAZ closed August at $65.14 and then closed September at $70.52, meaning if you owned it all month long, not just from the 14th to the end of the month, you only made 8.2%, (or 25% if you held until October 2, not the 50% if you held from the 14th until October 2).
Lastly, when you are trading leveraged ETF’s or ETN’s, you need to consider the ‘decay’ factor and how much the churning of options contracts is eating the fund itself. Over the course of a few days, the decay isn’t going to affect you too dramatically, but if you hold these products for weeks or worse months, the deterioration is going to eat into profits certainly.
Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513
Disclosure: This contributor did not hold positions in any of the companies mentioned. This contributor held long positions in Apple, Tesla, Intel, Google, Amazon.com, Facebook, Priceline and Microsoft at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
