Many investors are seeking the ability to add commodity exposure to their portfolios. This can be difficult for most home-based investors to achieve through traditional methods. Since the advent of exchange-traded funds, anyone with a brokerage account can now easily jump into the commodities market. When it comes to trading commodities, there isn’t an easier method than by utilizing commodity ETFs.
Why Natural Gas?
We can all remember hurricane Katrina, and the havoc that it caused on the gulf coast. Because of that natural disaster, many natural gas drilling rigs, shipping methods, and refineries located off the coast of Louisiana were damaged or destroyed completely. Shortly after, the price of natural gas, along with other oil products, skyrocketed. While it can be difficult to anticipate such natural disasters, this one was well announced, and many investors took advantage by gaining exposure in natural gas and other oil products.
Looking at the upcoming hurricane season is not the only indication of the possible price shifts of natural gas. Particularly hot summers can increase demand for natural gas, depending on the need from natural gas power plants. Extra cold winters will also strain demand, increasing the price.
Supply and demand is at the forefront when it comes to pricing of any commodity on the market, so an increase in demand (whether it be from global increases or natural causes) or a decrease in supply (from a storm knocking out production) will give the price upward correction.
One specific benefit of gaining exposure to natural gas in your portfolio is the ability to hedge against inflation. With an increasing global demand of oil-based products, positions of natural gas in your portfolio will help you keep up with increased inflation.
How to Trade Natural Gas
Trading natural gas the traditional way meant gaining access to a pit trader who would then allocate money towards natural gas futures contracts. Mutual funds that have positions in natural gas lack transparency and are riddled with fees. ETFs allow you the ability to bypass brokers and pit traders altogether, as well as increase the transparency in your investments.
ETFs in natural gas can track different aspects of this commodity, such as:
- Natural gas exploration
- Natural gas drilling
- Natural gas production
- Natural gas supplying
Diversified natural gas funds will include all of these at some pre-determined percentage. Exploration is a higher risk investment than supply; so many diversified funds spread the risk out based on their specific goal.
There are several different methods for trading natural gas ETFs. These methods are discussed below.
Index ETFs are funds that track a specific index. For example, as the Dow Jones USB Natural Gas Subindex goes up or down, so do specific ETFs that track this index.
Natural Gas Futures Funds
Most natural gas ETFs trade in futures contracts. Futures have a direct influence on natural gas prices. The natural gas ETF purchases the front month futures contract on the NYMEX, for example. When the front month is within 2 weeks of expiration, they will ‘roll’ the contract into the next month (or sell the position from the front month and buy positions in the next month). This ensures that your position in natural gas will always be ‘long.’
Leveraging is one of the great tools that often comes with ETF investing. There are many funds that attempt to double, triple, or quadruple your return. They achieve this through margin investing. For example, the ProShares Ultra DJ UBS Natural (BOIL) ETF tracks the Dow Jones USB Natural Gas Subindex, but is leveraged 2x in an attempt to double your return. It is not uncommon to find a 2x natural gas ETF or 3x natural gas ETF among the different leveraged natural gas ETF options on the market.
What if you want to bet against the price of natural gas and make money on it? There are two ways to go about doing this. You can short a natural gas index ETF, which would mean that as the index price decreases, you can sell the stock short and make a profit. There are also inverse ETFs available. These funds are basically doing the short selling for you, as they track the inverse of the index fund. Leveraging can also be applied to this investing strategy (for example, you could buy a fund that tracks the inverse of the natural gas index, but triples the return of the short position).
Trading ETF Options
Buying or selling call or put options for a natural gas ETF is another method for trading these funds. This is a great way to hedge against a future spike or severe drop in natural gas price, since you don’t actually have to allocate money until the strike price has been met.
Editor’s note – leveraged investing, margin investing, and options investing include substantially increased risk. Be sure you do your homework and understand exactly how your are allocating your money.
Natural Gas ETF List Of Options
United States Natural Gas Fund (UNG)
UNG was founded in 2007, around 2 years after hurricane Katrina. UNG invests in natural gas futures contracts traded on the NYMEX. It is a fund that seeks to replicate the performance of natural gas.
First Trust ISE-Revere Natural (FCG)
Founded in 2007, FCG seeks investment results that correspond to the price and yield of the ISE-REVERE Natural Gas Index. 90% of the funds are invested in common stocks that make up the index. It is an equal-weighted index that invests mostly in natural gas companies that get most of their revenue from exploration and production of natural gas. This is a non-diversified ETF.
SPDR S&P Oil & Gas Explor & Pro (XOP)
Founded in 2006, XOP tracks the performance of an index made up of the oil and gas exploration and production segment of a U.S. total market composite index. The fund utilizes a replication strategy in tracking the performance of the S&P Oil & Gas Exploration & Production Select Industry Index. XOP invests all but 80% of all assets in the securities comprising the index. XOP is a non-diversified ETF.
iShares Dow Jones U.S. Oil & Ga (IEO)
IEO was founded in 2006 and tracks the price and yield performance of the Dow Jones U.S. Select Oil Exploration & Production Index. The fund invests 90% in securities of the underlying index. The index measures the performance of the oil exploration and production sub-sector of the U.S. equity market. It includes companies that are engaged in the exploration for and extraction, production, refining, and supply of oil and gas products. IEO is a non-diversified ETF.
ProShares UltraShort Oil & Gas (DUG)
DUG was founded in 2007 as a leveraged inverse ETF. The investment seeks daily investment results that correspond to twice the inverse (-2x) of the daily performance of the index. The fund invests in derivatives should have similar daily return characteristics as twice the inverse (-2x) of the daily return of the index. DUG is a non-diversified ETF.
ProShares Ultra Oil & Gas (DIG)
Founded at the same time as DUG above, DIG seeks daily investment results which correspond to twice (200%) the daily performance of the Dow Jones U.S. Oil & Gas IndexSM. The fund invests in equity securities and derivatives that should have similar daily return characteristics as twice (200%) the daily return of the index. Like DUG, DIG is a non-diversified ETF.
These are a few of the options when it comes to natural gas ETFs on the market today, and this list demonstrates a good starting point to research for an investor looking to add natural gas commodity exposure to their portfolio. Search the natural gas ETF symbol for the respective fund that catches your eye for more information.
Adding commodity exposure through ETF investing to your portfolio is a great way to add diversity, as well as inflation protection. With the many advantages of ETF trading (intraday investing, low cost, transparency of assets), you can increase your bottom line with respects to investment results. Good luck and happy investing!
I have no positions in any ETFs mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: Please remember to do your own research prior to making any investment decisions. This article is not a recommendation to buy or sell any securities or stocks, and is the opinion of the author.