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Option Millionaires was started in February 2008 to provide traders with information about option trading. Led by three career option traders, whose pseudonyms are JimmyBob, UraniumPintoBeans, and Vantillian, they started one of the most popular option trading communities on the web. Now, Option... More
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  • You Might Want To Buy Gas This Week – And Stop Using Oil To Forecast Gasoline! 0 comments
    Mar 10, 2013 4:16 PM | about stocks: USO, UGA, XLE, OIL

    A Sigh Of Relief, To End Shortly

    The last month has provided a slight relief to the consumer, as the average price of gas declined over thirty cents per gallon since the Valentine's Day short term top. Of course, $3.65/gallon is hardly a relief, especially when compared against gas prices a decade earlier, but that's besides the point. The point is that, given current conditions, it appears that gas prices are about to make another thrust upward, and perhaps to new record highs, in the coming months.

    Higher Oil Means Higher Gas, Right?

    It's very intuitive, since crude oil is a major input in unleaded gasoline. However, it is only one of hundreds of the ingredients that go in the gas tank with each fill. Even so, the price of gasoline should follow the price of oil, right? Sort of.

    A quick comparison of the ETF (NYSEARCA:USO), which tracks the daily percentage change of crude oil futures, and (NYSEARCA:UGA), which tracks the daily percentage change of unleaded gasoline futures, shows that the relationships that the price relationships that most would consider obvious are quite weak. For instance, the correlation between the two ETFs is 41%, which is only moderately statistically significant. Another relationship measurement, beta, shows that for every $1 crude oil goes up, gasoline only rises $0.69, but UGA is just under its 2008 highs, while USO is more than 40% off of its 2008 high.

    For that reason, I suggest for most to use UGA to forecast gas price rises and falls instead of USO. For those who have access to futures charts, use the actual spot price charts of gasoline. In this post, I will be commenting on UGA.

    Underlying Strength

    The failure of a stock or commodity to become fully oversold represents strength in the underlying. Since November, gasoline has done just that. On the opposite side of that coin, if a stock or commodity becomes fully overbought, it shows strength in the underlying trend, and suggests that any existing uptrend is strong. In January and February, gas UGA became extremely overbought.

    In addition, gasoline's decline was halted right at a key support zone before climbing three percent on Friday. The level that gasoline bounced off of was the 38.2% retracement of the entire rally since November, and also the 61.8% retracement of the smaller rally that began in mid-January. Such a strong support zone is expected to hold. If it does not, a proportional target to the downside would sit near $58.00, about 8.5% below the current price.

    (click to enlarge)

    The Buy Signal

    Price, in fact, gave the trader's buy signal on oil. The decline from Valentine's Day could be described as the consolidation period from a "flag pattern." The pattern is easiest to see on the 60-day chart. The $70 target corresponds to roughly a 10% advance from current levels, or gas prices around $4.05/gallon.

    (click to enlarge)

    Given that the volume was weak on the breakout, I would take a half position on this breakout, and then after a pullback, if one occurs, enter the other half of the position. My stop would be around $60, but the probability of that occurring appears low.

    For those who would rather not dabble in the commodity world and buy gasoline futures/ETFs, look back to the title. How about you just buy gas for your car today? Happy trading!

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: USO, UGA, XLE, OIL
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