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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. 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 U.S. 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 July 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!

Source: How I Hedged Summer Gas Prices With ETF UGA