Gas Prices Drop Big-Time – How to Lock in These Prices as a Routine Consumer

by Darwin on October 7, 2013

gas pump

Over the past 2 weeks, we’ve seen gasoline prices in the US dip more than we’ve seen in over a year with a precipitous 14 cent drop according to a Lundberg survey out this weekend. On average, drivers paid $3.38 per gallon which is the lowest since 2012.

There are always several factors at play influencing gas prices, ranging from global economic events to refiner output and driving season coming to an end. None of that really matters to consumers though. What matters is the ability to lock in today’s low prices rather than enjoying a brief period of favorable pricing followed by the usual rampup again.

How to Lock in Today’s Low Gas Prices

There are two ways to take advantage of today’s low gas prices without having a complex Futures trading account set up which is not for routine retail investors. Within a few minutes, any one of us can have a low-cost stock/options trading account set up. That’s step 1. Right now, there’s a great sign-on bonus for 100 Free Trades at OptionsHouse available by following that link.

Next, you can take one of two different approaches to hedging your gas prices with the best available proxy for gas prices which is the ETF UGA. UGA is the US gasoline ETF and aside from trying to buy oil, refiners and individual stocks which may only moderately track the prices of gasoline, this is your best proxy.

Transaction #1 (Easiest):

You can simply go long UGA and buy an amount for instance, equal to what you intend on spending in gas for the next year. Let’s say you spend $2000 per year in gas. If you like today’s prices and bought $2000 in shares, an increase in gas prices of 25% would be offset by a 25% gain in the price of your shares. You can play this game as often and at whatever magnitude you like. Sure, there could be taxes on your gains, but if prices actually drop further and you lost money on your shares, those losses can be used to offset other capital gains on your tax return as well. Even risk/benefit.

Transaction #2 (My Favorite but Slight More Complex):

I like this options method a bit more because in my view, it provides a disproportionate risk/benefit. Since most stock options expire worthless, by selling an option, you make money every day as the time value drops off. In this case, you don’t really care much if UGA goes up or down since you’ll keep the full option premium on the contract you sold if prices rise, or if they drop, you recoup all the time value, pay for the difference in the actual price UGA dropped past the strike price and then enjoy the benefit of lower prices at the pump. Here’s a real-life example:

  • As of this writing UGA trades at $56/share
  • Sell 2 UGA Apr 2014 53.0 Put Options for 2.50 each
  • Income = $500 net of commissions

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 $500 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 April, UGA would have to be trading at (53-2.5 = 50.5) $50.50 per share or less. So, if UGA closes at $51, which would mean gas prices declined almost 10% from today’s price, you’d still have made money because you kept the premium of 2.50 each.

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.
How to Get Started Quickly

If you need an online brokerage account to get started, here’s an OptionsHouse Promo Code  to get 100 FREE TRADES to start, which will get you going for free initially!  If you’re going to sign up for an online broker or experiment with this hedging strategy, you might as well get something for free!

As a somewhat random yet related aside, you might enjoy reading about how much I calculated our roof-top carrier decreases our fuel efficiency on long trips.


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