United States Commodity Funds, the provider of the United States Natural Gas Fund (UNG) exchange traded fund (ETF), has been given the go-ahead for more shares. But the fund is now considering going further into the over-the-counter swaps markets. What does that mean for investors?

The providers fear that the Commodity Futures Trading Commission (CFTC) is about to enact some strict position limits, hence the decision.

As a result of new shares not being issued, UNG is trading as a closed-end fund at nearly an 11% premium to its net asset value (NAV), states Matt Hougan of Index Universe. The fund yesterday traded at a near-record premium of 9.8%. The record premium of 10% was set on Aug. 14. Investors seem to be betting that natural gas is due for a rebound, reports Asjylyn Loder for Bloomberg.

Hougan notes that there are three possible scenarios that could come out of this situation:

  • No new regulations and shares are issued as normal
  • New regulations, but room for more shares
  • New regulations, but existing shares are grandfathered in
  • Tough new regulations that force UNG to drastically reduce its size

What if UNG sticks with swaps instead of futures?  Generally, ETFs that invest in swaps receive the benchmark performance through the swap and the stock basket’s performance is given away, and performance issues are not a problem, states Genevieve Cua of Asia One Business.

The use of swaps help provide investors access to areas of the market that can be challenging to target, but they do come with risks, including:

  • They aren’t listed on exchanges
  • Liquidity and transparency are sometimes an issue
  • Since swaps are agreements between two parties, there is counterparty risk involved, writes Don Dion for the Street. In typical swap transactions, the two parties agree to exchange the returns. The risk is that the counterparty could default on its obligation.

For more stories on natural gas, visit our natural gas category.

Kevin Grewal contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.