Last week I did something I haven’t done for 5 years; I filled my gas tank for under $3 gallon.
This got me to thinking about ways to lock in current prices without pumping and storing hundreds of gallons of explosive liquids in my garage. We know the cliché, “there’s an app for that!” the same can be said for ETFs, “there’s an ETF for that!”. Doing a quick search for Exchange Traded Fund and “unleaded fuel” I found the UGA the United States Gasoline Fund, LP ETF symbol UGA.
Below is the description of UGA and a current price quote.
The ETF’s objective is to “reflect the daily changes in percentage terms of the spot price of gasoline..”. Therefore one share of UGA for $42.22 would be the roughly equivalent to $42.22 worth of gasoline. If I felt unleaded prices were going to increase over the next month and I knew I was going to consume 47 gallons of fuel over that period, I could do one of two things to lock in the current price. The first one is to purchase the fuel now and store it consuming it as needed. 47 gallons of fuel at current AAA prices ($2.76) would be around $130. I have no desire to purchase, transport and store 47 gallons of highly flammable liquid not to mention the fact that I would need to purchase proper storage containers. Couldn’t I just purchase $126.66 worth of UGA (3 shares at $42.22) and buy the fuel as needed? If unleaded fuel increases by 5% from $2.76 to $2.90 my 3 shares should also increase roughly the same percentage from $126.66 to $133. The $6.33 profit from the shares would offset the increased cost of fuel at the pump. What if the price of unleaded declined by 5% from $2.76 to $2.62? The 3 shares would also drop by roughly 5% but I would spend less at the pump offsetting the decline on the position Regardless of the move, I’ve already established my fuel costs. Essentially, I’d be locking in the price of fuel over the next month at the current price. This is what airlines do although they utilize futures and take physical delivery of their fuel, something we’ve already decided we don’t wish to do.
If you’re following along with this concept you’ve probably already found some of the major flaws with this plan. The first is that most of our vehicles don’t hold one month’s supply of fuel. Those 47 gallons probably represent two, three or even four trips to the pumps and it only hedges for one month with us essentially liquidating the shares at the same time as we take delivery of our fuel. That’s not efficient. The second issue is the cost to execute the trade in commissions pretty much eliminates our hedge. The third is that much of our fuel costs in California are the fixed taxes per gallon, the strategy doesn’t allow for this. Finally, what if I feel the price of unleaded will continue to fall? The answer is simple, don’t “lock in” prices until you feel prices have reached a bottom and you’re seeing evidence of a move higher. This approach to hedging gasoline has its flaws in execution but conceptually it’s sound trading theory applicable to many commodities we consume in our daily lives.
Going off of this basic approach to hedging my fuel consumption estimate over the next month, quarter or year, as an option trader I could utilize a variety of different strategies to establish a proper Delta. I could buy shares and sell calls along the way to realize any gains/losses or produce cash flow to purchase fuel.
I could sell puts to produce cash flow or take an assignment and then sell covered calls against those shares. I could build a shorter-term Bull Put Spread or even a Diagonal Spread and adjust each month depending on where the price of UGA is. Obviously, I have many approaches available and the trick is to build a position that isn’t over or under hedged to our consumption. However, it doesn’t appear I’ll be utilizing any of these strategies just yet. Until I see evidence in the charts and in the news that we’ve reached a bottom with a pivot, green candle and supporting volume, I’ll be keeping my options open and my gas tank at 3/8 or lower…