How to Trade Natural Gas Without Blowing Up Your Account

I remember a conversation with a trader friend who had just taken a bath in natural gas futures.

“It was going great until it wasn’t,” he told me, nursing a beer and his wounded pride. “Made 40% in three months, then lost 60% in three days.”

His story isn’t unusual. Natural gas markets are notorious for creating and destroying fortunes with equal efficiency. The infamous “widowmaker” trade has humbled everyone from retail rookies to hedge fund billionaires like Brian Hunter, whose Amaranth fund imploded spectacularly while trading natural gas spreads.

Take a look at this price action in natural gas futures over the last ten years:

Image courtesy of TradingView

Wild, to say the least!

But beneath the chaos lies opportunity – especially for systematic traders willing to do the work and approach this difficult market with the humility it demands.

A Warning Before We Begin

Let me be absolutely clear upfront: natural gas is a specialist market. If you’re a newcomer and you think you’ve spotted an obvious edge or opportunity, you’re almost certainly missing something.

As the old saying goes, “If you’re sitting at the poker table and can’t figure out who the sucker is, it’s you.” This applies doubly to natural gas markets, where sophisticated players have spent decades understanding every nuance.

The most effective way to keep risk under control is through position sizing. Keep it small and rebalance when volatility spikes or the position grows on you.

Consider yourself warned. Now let’s dive in.

Understanding Natural Gas Markets: The Basics

Natural gas markets exhibit unique characteristics that make them fascinating trading vehicles:

Pronounced seasonality: Demand spikes in winter for heating and summer for power generation, creating predictable (but not identical) yearly patterns.

Storage-driven price dynamics: Unlike many commodities, natural gas storage has hard physical limits, creating price floors and ceilings.

Weather sensitivity: A 5-degree temperature swing can dramatically shift supply-demand balances.

Production inelasticity: Gas production can’t quickly respond to price signals, creating lag effects.

Check out this chart of gas production and demand:

Image courtesy of ICE

The seasonal nature of demand is obvious. You can also see how demand is inelastic – it doesn’t change much based on production. Production is more fixed, showing only a small seasonal effect relative to demand, and growth over time.

These characteristics make natural gas fertile ground for systematic approaches. But before diving into strategies, let’s examine the various vehicles for gaining exposure.

Natural Gas Vehicles: Choosing Your Ride

Physical Natural Gas

Verdict: Not even worth discussing for anyone reading this article.

Natural Gas ETFs/ETNs

Let me share a cautionary tale from former SIG market maker and options trader Kris Abdelmessih. Back in 2009, he was trading natural gas options and UNG (United States Natural Gas Fund) options for a backer. As a former market maker at SIG, he thought he understood the arbitrage opportunities between UNG options and natural gas futures options.

Then came a bunch of regulatory scrutiny around funds facilitating speculation that would drive up the prices of basic goods. UNG announced it would cap share creation, causing the fund to trade at a massive premium to NAV (around 20%) due to the shortage of shares.

The result was that UNG was no longer wired to NG futures, and the “obvious” arbitrage trade broke down. Every time gas futures sold off, UNG barely moved as the premium expanded. When gas rallied, UNG still barely moved as the premium contracted.

The lesson is that in a market like natural gas, market risks (prices moving up and down) are trivial compared to rule changes and structural shifts. A seemingly simple trade can become a nightmare when the underlying mechanics change.

Read more about Kris’ experience here. It’s very illustrative.

Verdict: Fine for short-term directional bets measured in days or weeks. Avoid for longer timeframes unless you’re explicitly using them for roll yield strategies (more on this later). If you notice an “obvious” trade, consider that there’s almost certainly more to the story.

Natural Gas Futures

Verdict: The primary vehicle and tool of choice for serious natural gas traders.

Options on Natural Gas Futures

Let’s talk about how natural gas options differ from equity options, because this trips up many newcomers (including me, until I did my research for this post). In equities, every option expiry references the same underlying – the stock price. If you trade September, October, or November SPY options, they all reference the same underlying.

Natural gas is completely different. Each month’s futures contract is a separate underlying with its own price. March (H) futures might trade at $5.50 while April (J) futures trade at $4.0. This means the H $5 call is almost $0.50 in-the-money while the J $5 call is a full dollar out-of-the-money.

Even more confusing: even if H and J were trading at the same price, the H $5 call could trade over the J $5 call if H implied volatility is high enough to overwhelm the time difference. You can see how an equity options background might not serve you so well in this market.

Verdict: Excellent for harvesting volatility premium or expressing defined-risk views on an inherently spiky market. Not suitable for beginners.

Calendar Spread Options (CSOs)

A specialist instrument even within the specialist natural gas market. CSOs are options on the spread between two futures contracts, like the infamous March/April (H/J) spread – nicknamed the “widowmaker” because of its ability to destroy trading accounts.

The H/J spread represents the difference between late winter gas prices and shoulder season prices. When H trades above J (backwardation), the spread is positive. When H trades below J (contango), the spread is negative.

The natural gas market is often “too smart” for typical options strategies. What I mean is that an equity options trader might look at the prices of these spread options and think “opportunity” when the truth is that they’re actually trading very close to fair value thanks to the unique dynamics of this market.

For example, even when the H/J spread is trading at $1.50, the options market might be pricing in almost no chance of it settling above $3, with the highest probability that it collapses back to zero by expiration.

Verdict: Only for specialists with deep market knowledge. The complexity creates opportunities but also massive traps for the unwary.

CFDs (Contracts for Difference)

Verdict: A sub-optimal substitute for futures, but sometimes the only option depending on your location. If using CFDs, be wary of overnight financing costs.

Now that we’ve covered the vehicles, let’s explore some potential strategies.

Natural Gas Trading Strategies

1. Mean Reversion Strategies

Possibly due to the somewhat predictable supply and demand dynamics, natural gas tends to go through periods of mean-reverting behavior.

But this predictability is really only broadly applicable (increased heating demand in winter, for example), and the common short-term surprises (such as an unexpected cold snap) mean that prices can go a long way – further than your margin will stretch – before they revert.

The simplest of mean reversion strategies (Bollinger Bands with a 20-day lookback) made money over the last 15 years, according to a simple TradingView backtest:

Image courtesy of TradingView

The success of such a strategy depends on continued mean-reverting behavior in the future and management of the inevitable drawdowns.

2. Cointegrated Spread Trading

Research by Rachev et al. (2009) models natural gas crack spreads (the spread between natural gas and products derived from it) using a mean-reverting model.

Trading the model generated about 20% per annum in excess returns in a ten-year, before cost backtest.

A practical implementation involves:

• Trading the spread between natural gas and oil futures
• Establishing the fair-value relationship through regression
• Entering when the spread exceeds 2 standard deviations from fair value
• Exiting when the spread reverts to the mean, or after a set number of trading days

The benefit of this approach is that it’s relatively market-neutral – you can make money regardless of whether gas prices rise or fall, so long as the relationship between the paired assets returns to the recent average, which, of course, is another question altogether and not something that should be assumed.

3. Calendar Spread Strategies

Futures calendar spreads involve buying one contract and selling another one with a different expiry date and profiting from the expected convergence of the price of the two contracts.

Example calendar spread

The seasonal patterns of natural gas create structural opportunities for calendar spreads driven by seasonal demand dynamics. These have historically been good, albeit noisy, trades.

An example of a seasonal calendar trade is buying early summer contracts and selling early winter contracts, mimicking what physical storage operators do – buy cheap summer gas, store it, and sell expensive winter gas – but does it through the futures market.

There’s a good underlying hypothesis for the trade: gas is more valuable in winter than summer. But be aware that such a trade requires careful oversight, as short-term surprises can cause huge dislocations.

Finding an Edge in the Market’s Periphery

One advantage we have as indie traders is the ability to pick and choose where we trade. And for beginners, one of the smartest things you can do is to recognize that trading mispricings in natural gas is a highly competitive game that you don’t even need to play.

So instead of banging your head against the wall in natural gas, where some of the smartest traders on the planet have been duking it out for decades, you’re better off using it as your baseline of “fair” pricing.

You’re exceedingly unlikely to outsmart professional natural gas traders in their area of expertise. But what you can do is listen carefully to what they’re saying and apply those insights where others aren’t.

This approach is as old as the market itself. Instead of focusing on natural gas itself, you might track how it’s priced, then apply those insights to more obscure markets that the natural gas traders aren’t paying attention to. You’ll find cases where markets impacted by the natural gas price haven’t fully incorporated what the gas market is saying about future price movements. This represents an opportunity.

So you go hunting for assets that respond to natural gas but do so in a clumsy, ham-fisted way. Maybe it’s a utility stock whose investors don’t fully appreciate the term structure of gas prices. Or it’s a regional gas ETF where the participants are using simplistic assumptions about how prices revert. It could even be a small-cap industrial company whose profitability is tied to gas prices, but whose stock hasn’t reacted to what the gas options market is implying about future volatility.

The point is to leverage the gas market’s collective intelligence rather than fight it. Let the gas nerds battle it out in the main arena while you pick off opportunities in the periphery where that information hasn’t fully percolated.

This isn’t just theory – it’s practical trading wisdom. The edge isn’t in natural gas itself, but in the information asymmetry between the hypercompetitive core market and its less sophisticated satellites. Gas is telling you something valuable. You’re just applying that insight where fewer people are listening.

And the beauty of this approach is that you don’t need to be the fastest or have the best data feeds or algorithms. You just need to be thoughtful about where information flows slowly and apply your insights there. It’s like having the answers to tomorrow’s test today – you just need to find someone still studying the wrong material.

Risk Management: Don’t Get Blown Up

Before rushing to implement these strategies, a serious word about risk management.

Natural gas is among the most volatile major commodities. Single-day moves of 5-10% and annualized volatility north of 100% are not uncommon. Weather pattern shifts and geopolitical supply shocks can create swift, brutal price action. Position sizing should respect this chaos.

Final Thoughts

Natural gas offers opportunities for systematic traders willing to respect its unique characteristics. The strategies outlined above have worked in the past and are a good place to start.

Personally, I lean towards simpler strategies such as seasonal trades and calendar spreads – they’re harder to mess up and are almost impossible to overfit.

However, I’d be remiss not to emphasize that success requires more than just the strategies themselves. It demands:

• Rigorous risk management – position sizing and diversification of edges
• Mechanical execution during periods of underperformance
• Constant monitoring of structural market changes

Most importantly, it requires humility. If something in natural gas looks like an obvious opportunity, it’s probably not – or at least, not in the way you think. The market is fiendishly sophisticated, with participants who have spent decades understanding every nuance.

Probably the most humble approach is choosing to play in less competitive arenas, but armed with knowledge from competitive markets like natural gas.