'Wait 'Til Next Year' - Lifestyle Hedging

Includes: DBA, USO
by: Reel Ken

Growing up in New York in the 1950's meant you were either a Brooklyn Dodger, NY Giant or Yankee fan. For me it was the Brooklyn Dodgers.

Unfortunately, it seemed that every year they would lose to the Yankees in the World Series. All I had to console myself was the perennial Dodger mantra..."Wait 'till next year".

One time, quite by accident, my dad revealed to me that he bet on the Yankees every year. This was astonishing, given that he was neither a betting man nor a Yankee fan. Pressed to defend this heretical act, he explained simply that if the Dodgers won, he would be so happy, losing a few dollars didn't matter. In fact, if he could, he would gladly pay the heavens if the Dodgers would win. On the other hand, if the Dodgers lost, he made some money and it softened the blow. It made so much sense to me, this was a strategy that I would employ continuously through my life.

It wasn't till quite a few years later, in business school, when I learned about hedging, that I realized what he was doing. He was simply hedging two resources (emotional and financial) so as to assure gain regardless of outcome.

Now, I've written extensively about hedging portfolio returns. But, there is also a different type of hedging..."Lifestyle hedging".

For instance, oil prices have fallen and many see this sector as an investing opportunity. But there is also a corresponding "Lifestyle" issue. If oil prices do go up, we all pay more to run out cars. I estimate that I spend about $3,000/year for auto-gas and another $2,000 for the boat. If oil climbs 20%, these expenditures will rise by $1,000, or more.

So, I simply hedge this by going long on oil. There are many ways to do this, but I use the US OIL FUND ETP (NYSEARCA:USO). There are "tracking and contango issues" but I have to choose something and this seems simple enough.

The way I hedge is to sell a put to generate $1,000 profit if oil goes up. This will offset my increased lifestyle expenses. With USO trading at $31.83, the January 2013 $31 strike put credits $2.73, or about 8.5% of the trading price. Selling four puts generates a credit of $1,092.

If USO goes up, I make the "lifestyle offset". If USO goes down, my lifestyle expenditures go down. Now, I do have a 8.5% cushion on the downside, so I could actually be a win-win on a small move in either direction, but that's not my objective.

Of course, oil isn't the only living expense. There is also food. The Powershares Agriculture Fund (NYSEARCA:DBA) is one of many choices. It is currently trading at $28.22 and the January 2013 $28 put sells for $1.35, about 4.8% of the trading price. Once again, just estimate food expenses and sell enough puts to create an offset if prices rise.

I heat my home with natural gas, so I can apply the same principles here. This is particularly promising as nat-gas is very low now and a sizeable up-tick would mean much larger heating bills.

In today's market place there are investments for about everything. One could keep going down the line and hedge against more lifestyle expenditures, but you get the picture.

Keep in mind that these are not plays just determined to make money. In fact, I'd be quite happy if they broke even. That would correspond to a 5% to 8.5% reduction in my living expenses. Now, this doesn't preclude me from making bigger investments in these sectors as part of an investment plan.

This particular strategy could be especially helpful to those at or near retirement and with limited funds or fixed incomes.

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

Additional disclosure: I buy and sell options on USO, USG, DBA