With oil prices hovering over $100 per barrel again and the summer driving season approaching, Americans are rightfully fretting over what they’re going to be paying at the pump as tensions continue to flare in the Middle East and the nuclear accident continues to unfold in Japan. Gas prices tend to rise annually during the summer driving season anyway, so it shouldn’t come as a surprise if prices continue to rise from the current levels of close to $4 in many states.
There are various ways to hedge your own energy costs which I penned a while back, but since I just did a transaction last week, I thought I’d share the actual details. Of the various ways to hedge energy costs, I chose to focus directly on gasoline prices since there isn’t always a direct correlation to oil prices given the refining situation in the US. Maybe it’s just me, but it always seems like gas prices are quick to rise when oil rises, but slow to fall when oil declines. Additionally, if refining capacity were to become constrained again, gas prices could remain high while oil prices dropped.
Therefore, I used the best proxy for gas prices out there, the gas price ETF with ticker symbol UGA. While one approach would be to buy shares of UGA, I chose to sell a put option.
Transaction:
- I sold 2 UGA Jul 16 2011 50.0 Put Options for 1.90 each
- UGA was trading at around $53 per share at the time of the trade and 52.45 as of Tuesday’s close
- Income = $380 net of commissions
Outcomes
I know, this isn’t a big trade, this is more of a personal finance balancing act. Our family only consumes a few hundred dollars in gas a month, so if gas prices spike, the $380 will help blunt the increase. Should they decline, then I’m paying less out of pocket even though I may lose money on the trade. In order to lose money on the trade actually, at expiry in July, UGA would have to be trading at (50-1.9 = 48.1) $48.1 per share or less. So, if UGA closes at $49, which would mean gas prices declined almost 10% from today’s price, you’d get to keep the full premium.
This method is essentially what businesses and municipalities do on a larger scale though. If you’re running a business that relies heavily on gas prices, you may want to hedge in this fashion (airlines do). If your input costs are heavily dependent upon any other raw material, if you can hedge it, you may want to do so to smooth out operational risks. There are numerous commodity ETFs to choose from to see where else you can hedge costs that impact you – food, coffee, oil, you name it!
- How to Get Started Quickly – If you need an online brokerage account to get started, here’s an OptionsExpress Promo Code to get 50 FREE TRADES to start, which will get you going for free initially!
Do You Hedge Anything?
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I’ve done a little reading on options and hedging but have never delved to deep into it. I think in the short term I’ll keep it like that and depending on what my living situation is like in the future I may pursue this avenue. Awesome post and thanks for the basics on a put.
-Ravi Gupta