The Heller Angle – July 16th, 2020

Hopefully by now I have setup a framework to help those reading this how I look for trades. First and foremost I put on my risk manager hat and have a plan in place in case my fundamental and technical view is wrong. Every trade so far has been a winner, but these are the kinds of trades that should win 95% of the time. One needs to be prepared for when a trade does go wrong. I bring up risk management because after my post a week ago there was a good discussion on twitter that I have linked below. Thank you to those who contributed on the thread.

I probably sound like a broken record at this point but due to the unknowns with Covid-19, I am trading with credit spreads only so that I know my maximum risk when I make the trade. I will someday in the future trade in ratios and have uncovered options from time to time. Again putting on my risk hat, it is important to have a plan ahead of time to manage uncovered options.

One of the contributors (Jacob) discussed how he had bought call spreads and as the trade worked he turned that long call spread into a ratio of 1 long call vs 1.25 short calls. What he did there in my view was to take off a little bit of the delta exposure he had by selling calls but still was delta long. If trade had pushed up closer, at some point his deltas would have flipped negative. There are plenty of ways to manage risk at that point, does the trader exit the entire position? Does the trader look to buy another call above it turning it back into a balanced position (something like a call butterfly)? Does he buy the futures to cover the upside risk (which then opens up more downside risk) because their fundamental view has changed and doesn’t mind the downside risk. I agreed with his view and thought it was unlikely NG was going to run up very far. A few days later as the price of NG price chopped around and a few days passed by, theta decay occurred and he was able to buy back the extra calls sold for a profit. His ratio moved back to 1:1 and had some profits to cover a loss if NG moved lower. This is very good trading in my view.

Another topic discussed is the risk/reward of doing tiny spreads like the ones I have currently been doing. I am far out of the money (OTM) but my risk/reward loss ratio is high if NG moves significantly lower. Risking potentially ~0.14 to make 0.01 might not make sense to everyone. If I don’t feel strongly on how NG will move in the next 2 months but feel comfortable that NG will stay above 1.50, I can setup these trades and profit from that.

One way I could setup a trade with a better risk reward would be closer, such as 1 straddle away vs 1.5 straddles away, and also longer time periods like 90 days vs usually 45 days or less. A trade like that might make 25-33% of the width of the spread. You will see me do those types of trades, just not right now with all the uncertainty in the fundamentals on both the supply and demand side.

So let me now get back to fundamentals. I have not discussed fundamentals much, mostly because I don’t think they have changed very much these past few weeks. I do however feel that something has fundamentally changed on the demand side that makes me slightly less cautious.

As we all know, a few months ago the entire US basically did a hard shut down and then started opening back up. With cases rising again, I started watching hotspot areas Arizona, Texas, and Florida to see how they would react. The big change I have noticed is that government officials are now trying to do more targeted closings. For example, in Arizona, the state has required indoor restaurant seating to 50% occupancy vs shutting all seating down and only allowing takeout. When we started opening back up, 50% was only recommended and not required (no idea how many followed the recommendations). While this is just one example, there are countless others that show a targeted response versus complete shutdown. Essentially demand will still be reduced, but not as signifcant as in in April / May. Of course, some lock downs are the same as before, gyms are shut down in Arizona but others like malls and retail are open but require a mask. Overall, I do not see hard shutdowns happening, which makes me more comfortable with demand and adding more exposure back with credit put spreads.

Since I have not been writing here for very long, I want to be clear that I still have smaller than normal positioning size and will continue to do so. This spring and summer I have been trading at approximately 50% of size relative to 2019 and plan to maintain that as a maximum. Currently, I’m way below that as I wanted to see how these hotspots handled their phased re-openings.

As a good risk manager, continue to stay vigilant regarding the risk. Experts think winter is going to be worse for Covid-19. Some thought there would be a lull this summer so we cannot be 100% sure. If Covid-19 does get much worse this winter, places could go back to back to very restrictive shelter in place orders versus stay at home recommendations / requests.

This post is quite long already so I will try to post tomorrow or sometime this weekend additional thoughts on LNG (bullish) and supply (less bullish than I have been) but overall net slightly more bullish than I have been previously on a short term basis.

The current NG price for Sept is 1.778. 1.80 straddle prices are 0.30 and 1.75 straddles prices are 0.31. 1.5x straddle prices away is approximately 0.45 with 41 days until option expiration. 1.30×1.15 put spread can be sold for 0.010 at the ask. I have orders in for 0.011 and 0.012.

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