How to Hedge Gas Prices and Put Money Back in your Pocket

What if I told you that you didn’t have to wrestle with skyrocketing gas prices again this summer like 2008?  With oil prices reaching new highs again and gas prices trailing in lockstep, it’s time to think about how to hedge your exposure to increasing fuel prices and save money on gas by whatever means possible. There are various ways to achieve a natural hedge on energy prices, and I’ll cover each in detail below – from the simple to the moderate level of effort/expertise required to ensure that you’re recouping your energy outlays if prices continue to spike, which they often do each summer.  It’s also worth considering that between piracy on the high seas and fireworks brewing in Iran’s elections this summer, which wields substantial influence over global oil prices, it takes very little to set off a superspike in oil prices, which indirectly impacts your fuel cost outlays.  A key consideration here is what you anticipate your actual gas outlays will be this year at current prices.  i.e. you shouldn’t be spending thousands of dollars buying options as outlined below if you only spend $1000 per year on gas.

With airlines and manufacturers hedging their fuel prices, why aren’t individual consumers?

Hedging Your Fuel Prices

Buy the Gasoline ETF – A long awaited US gasoline price ETF was finally launched in 2008.  Initially, the ETF had very low volume and early investors were frustrated by a seeming disconnect between the underlying price changes and the actual price of gasoline at a time when prices were skyrocketing at the pump.  Now, due to increased trading volume and market efficiency, the ETF seems to track changes in gas prices much more closely.  Take a look at the chart below showing how you could have done in the Gas ETF UGA compared to the S&P500 which is no slouch.

A simple way to hedge would be to simply buy enough shares to cover a portion of your gas expenditures such that if UGA rises with the cost of gas, the extra money you’re paying out of pocket for gas is offset by gains in your trading account.  Likewise, if UGA drops in price, you’re paying less out of pocket for gas.  Since this is not an option with an expiration period, you can simply hold this position for as long as you like.  And if gas drops and you take a loss on UGA, you even get to write off the tax loss!

Buying the Oil ETF– Since oil is one  of the most efficiently traded commodities on earth and oil prices tend to increase the cost of everything from food to clothing to toys, some people prefer to hedge against oil prices and ignore gasoline.  With crack spreads, refinery capacity and other factors at play, there are occasions where gasoline prices and oil prices are not completely correlated.  As such, the two primary oil ETFs are USO and USL.  A similar simple approach to going long with either ETF as outlined above is applicable as well.

Buying the Natural Gas ETF – I just wrote a pretty lengthy article at Everyday Finance on an anomaly that’s forming on the natural gas ETF UNG due to oversubscription of shares from investors piling in that leaves the holding company unable to keep up with demand.  You may want to approach this with caution (or speculative enthusiasm), but the option does exist to hedge your natural gas prices to some degree nonetheless.

Now for the more complex hedging strategies…

Sell Puts a Gas ETF– While the prior hedging strategies require cash outlays to buy either of the ETFs, you can also employ hedge strategies that bring you income if prices stay the same or rise.  However, if the underlying commodity price drops, but selling puts, you are forced to either buy or close out your position at a lower price.  If you’re hedged conservatively, that’s fine.  Here’s how it works in more detail:

UGA ETF current price: 34.30

UGA 30 Put Oct Strike: 1.1

Here’s what this means: The current price of the ETF is $34.40 and it trades just like a stock.  You can SELL the put listed above and capture $110 (less commissions of course) in option income.  Since UGA is acting as a proxy for US gasoline prices, as long as UGA trades above $30 per share by the 3rd Friday in October (options expiry date), the put that you sold to someone else will expire worthless and you will get to keep the full $110.  If the price of gasoline plummets, you’ll owe the difference*100 (since an option contract controls 100 shares), but of course, now you’re paying much less out of pocket for gas.  So, if the price of gas drops 20%, UGA would trade down to ~$27.5 per share and you’re either owe $250 to close out the position ((30-27.5)*(100)) or if you did nothing, you’d be forced to buy UGA for $30 per share. Since it would be valued at $27.50 each, you’re effectively out $250 either way.  The key is, you’d want to make sure that your gas expenditures justify losing $250 if gas prices drop 20%.  If you spend quite a bit on gas, like say, the owner of a landscaping company or of course, an even larger medium sized business, you could just multiply the factor and sell as many options as you desire.

Sell Puts on an Oil ETFs –   If you perform the same exercise with an oil ETF like USO, which is traded more efficiently with higher volume, you’ll get a slightly better premium, but be mindful that oil and gasoline don’t always track in perfect lockstep.

USO ETF current price: 39.43

USO 35 Put Oct Strike: 2.25

In this case, you’d capture $225 for the option as long as oil doesn’t drop 11% or more.  See the above example for the same concepts.

If you don’t have a brokerage account (or even set this up on the side to retain your other benefits of a higher priced account), I recommend the low-fee/FREE, best in class Zecco.  In order to buy and sell options, you’ll need to sign up for options trading and sign off that you understand the risks involved (you should understand these risks of course – here are some example articles for more examples on trading options – (Google here and here and how to profit from employee stock options regardless of share price.

Short the Energy Industry with Inverse 3X ETFs – While the option exists to short the energy sector on a triple leveraged basis as I outlined in this article on 3X ETFs– the Riskiest ETFs on Earth, I don’t advise this as a long term hedging strategy, since as I outlined in the article that these are daily rebalanced ETFs and they lose value quickly over time, even if the underlying index moves in the desired direction.  I utilize them occasionally for opportunistic trades, but not for long term hedging/investing.

Use Intrade Binary Options to hedge against Gas Prices – Intrade is a little known futures market for everyday people.  I’ve done Intrade reviews before on how you can bet on everything from presidential election results to whether swine flu cases will hit so many cases in the the US by a certain time, to how to bet on the end of the world to, of course, commodities prices like gas.  There is a US gas exchange whereby you can buy futures for gasoline hitting a certain price by a certain time, like say, $3.00/gallon by August – and your futures position moves to 100%, capturing the remaining premium above what you paid.  Conversely, you can sell a futures contract for gas at say, $2.00 in August (wouldn’t a return to $2 gas be great?) and each time you keep rolling this position month to month and gas never gets that low, you continue to capture the premium.

Saving Money at the Pump – There are myriad articles out there on how to save money on gas and rather than rehashing them. An obvious quick win which is a complete no-brainer, is to use the Best Gas Cash Back Credit Card out there which presently appears to be this 5% Cash Back from Chase.  If you have the discipline to pay your credit card bills off monthly, you’re leaving cash on the table by not taking advantage of free cash back by simply charging your gas purchases. For maximum choice and comparison though, I rely on cash-back credit cards for as many expenses as I can and NEVER carry a balance (that’s the catch!). But, by doing so, we get back hundreds of dollars per year in tax-free income for doing nothing but carrying less cash around and exercising discipline.

In summary, there are a multitude of ways to hedge your gas expenditures and save money at the pump.  Some hedging strategies require cash outflows with no subsequent risk while others have the benefit of immediate income with the risk of loss later if energy prices plummet.  Just make sure you estimate your actual gas expenditures during a given time period and ensure the hedging strategy you chose makes sense and you’re not “over” or “under” hedging to such a degree that the strategy didn’t make sense.

Tagged as: ETF, hedging, oil, Options, UGA, UNG, USO