The world is floating on a bubble of natural gas. There’s so much of it drifting around — in liquefied natural gas tankers, in tank farms and waiting to be pumped out of each newly discovered gas field — that the oil/natural gas price ratio has risen to 18 from an average of about 8.6 since 1994.

(The ratio is based on the fact that a barrel of oil releases about 5.8 million British thermal units, so a barrel of oil should be priced about six times that of natural gas, which is priced per million BTUs.)

Counterintuitively, however, it may not make sense to be bearish on natural gas. Demand for natural gas as a clean-burning alternative to oil is unlikely to diminish in these carbon-sensitive, eco-obsessed days, as most North American natural gas goes to power generation. According to the Wall Street Journal, futures markets are pricing December 2010 natural gas contracts at $7.25 per million BTUs, implying an oil/natural gas price ratio of 10.8.

But with oil prices also firming, and the near-term outlook indicating increasing demand based on a global economic recovery, aggressive options traders might establish longer-term bullish positions on major oil and natural gas producers such as Talisman Energy Inc. and Canadian Natural Resources Ltd.

When you look at bullish option positions, buying calls is typically the strategy of choice — but not always the right choice. For example, covered call writing or cash-secured put writing are bullish strategies — albeit with limited upside.

The issue is whether you are willing to pay the cost of the option (in an option-buying strategy) or prefer option-writing strategy, in which you collect the premium. The choice comes down to whether you think the options are overvalued — in which case, an option-writing strategy would make the most sense — or undervalued, which would suggest an option-buying strategy.

A simple way to establish an under- or overvaluation is to measure the volatility implied by the options vs the historical volatility inherent in the underlying stock. With Talisman, for example, the historical, or actual, volatility is 33%. The volatility implied by the longer-term at-the-money option is 31%, suggesting — on the surface, at least — that Talisman options are not overvalued.

Of course, this analysis comes down to your view on future volatility vs the market’s view. Historical numbers provide a snapshot; future volatility is a judgment call.

CNR is displaying similar traits, although the underlying stock has periods during which it can be quite volatile. Historical volatility for CNR is 34%, compared with an implied volatility of 35.5% for the January 2010 at-the-money calls.

If we are judging the merits of an options strategy based on future volatility, then we should return to the longer-term picture for natural gas. Given current pricing for longer-term calls — and the potential upside, should natural gas prices normalize (assuming that oil prices remain where they are or rise) — you could argue that buying calls is probably the best way to take advantage of the upside potential.

If Talisman is the underlying stock of choice, bullish option traders might consider the Talisman January 2011 20 calls trading at $3 a share. Note that these calls expire in January 2011.

With CNR, I would not consider the January 2011 72 calls at $14 a share. The problem with the longer-term options on CNR is the lack of liquidity. At the time of writing, the closing spread for these CNR calls was $1.40 (bid of $12.70, offered at $14.10). A spread that wide is not indicative of a market-maker serious about trading the options. And as we are usually trading against the market-maker, it would be difficult to exit this position if CNR rises sharply over the next six months.

That said, a better choice would be the cash-secured put. You would sell the CNR January 2011 70 puts at $4.20. These puts are trading with a tighter spread (bid of $4.10, offered at $4.30 at the time of writing), so you should be able to enter a sell order at a price that is the midpoint between bid and offer.

Note that this strategy obligates you to buy CNR shares at the put’s strike price. If the stock is trading below $70 at the January expiration, you will be required to buy the shares. If they are trading above $70 a share at expiration, the puts will expire worthless and you will keep the premium received.

@page_break@In order to ensure that you are holding a cash-secured position, thus avoiding the potential of a nasty margin call, you should make certain that put-writing clients have sufficient cash on the sidelines to meet the put’s obligation.

Assuming you buy the natural gas storyline, you should be willing to exit your long call or short put position if natural gas prices rebound over the short term. IE