Ultimate Guide to Natural Gas Futures, Part 1

Since futures contracts have an expiration date, it is impossible to buy and hold. Commodity trading strategies take this into consideration and determine which contracts promise the best return. In the case of UNG and GAZ, the funds use a simple strategy that exposes them to gains or losses, depending on where there is backwardation or contango.

For instance, say natural gas for October delivery costs $2 and natural gas for November delivery costs $4. If a trader holds 1,000 contracts at $2 and rolls monthly, he will only hold 500 contracts after the roll, assuming no transaction costs. This became a major issue with UNG because it grew to such a large size.

When UNG rolls, its selling and buying cause the contango to widen, and since it publicly announces its roll dates, other traders can profit from UNG's "largesse." UNG shareholders suffered losses as they sold at lower prices and bought at higher prices. Currently, contango is especially large, due to several factors, which I have written about previously, and this makes this situation even worse.

Conclusion

Strictly speaking in terms of a head-to-head comparison of these two funds, ignoring whether natural gas is a buy or sell, ignoring the contango and ignoring whether it makes sense to pay a premium, GAZ is currently the better choice between these two funds.

-- Written by Don Dion in Williamstown, Mass.

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