Hedge Your Gas Prices

I’ve written plenty about gasoline lately, but only about gas taxes.  Let’s shift gears a bit…  Do you think gas prices will increase?  If gas prices increase, is there a way for you to hedge against that increase so it doesn’t affect you?  Of course!

Opportunity Costs and Taxes

I’m going to open this article up with some caveats… opportunity costs and taxes.

An ‘opportunity cost’ is what you are giving up in order to put a strategy into effect.  In this case, what you could be making when you’re implementing this strategy versus what you can save is your opportunity cost.  Clipping coupons for hours to save a few dollars is an opportunity cost.  If gas prices increase enough, it may be worth your while to consider these strategies.

Taxes are another consideration you’ll have to note.  If you enact these strategies in taxable accounts, you will have to pay taxes on any gains you book because of increases.  This can quickly eat most of the profits you make.  You’ll have to consider your own tax situation… tread carefully and seek advice from the right sources (like an accountant).  Know that nothing in this article should be considered financial advice… just ideas.

ETFs Make it Easy

Hit the Road... from HeyThereSpaceman
Hit the Road… from HeyThereSpaceman

The simplest way to hedge your tax prices (outside of buying a Hyundai and locking in $1.49 gas for a year) is to buy a gasoline linked ETF (Exchange Traded Fund).  Take a look at UGA, which is linked to the the gasoline futures contract.  Regular gas is currently averaging $2.63 a gallon, nationwide, and UGA closed today at 31.93.  This means for every share we buy, we are hedging 12.14 gallons.  How do we use this information?

Joe Sixpack drives 12,000 miles a year.  In California, AAA reports the average price of a gallon of regular gasoline as $2.99.  10.67 gallons are represented per share of UGA.

Joe drives a 2009 Ford F-150 and gets an average of 18.5 miles per gallon.  He needs about 648.65 gallons of gas a year.  He should buy 61 shares of UGA for a year’s worth of hedging.

Did Joe make a good choice?  If the price of gas stays exactly the same, Joe will buy his 648.65 gallons at the same price, and his UGA will theoretically stay the same price.  How about if it goes up 10% overnight?  California gas will then cost $3.29 a gallon, and UGA’s share price will (theoretically) increase to 35.12.  Joe will lose $194.60 ($2134.06 – $1939.46) on the price of gas.  However, he will make $194.59 ($2142.32 – $1947.73) because of his hedge.  Good work, Joe!

That Wasn’t Too Hard

You can make it more complicated if you want.  Shorting UGA will allow you to bet gasoline will fall (but you’ll have to buy the gas and you’ll have a loss if it goes up!).  Another strategy you could use is to buy or sell options on UGA, to give yourself some leverage (Joe had to put up $1947.73 to buy his shares of UGA).  One strategy would be to sell puts on UGA, which would give you money immediately, which you would then keep as long as UGA was trading above its strike price.  Read this great post for some examples of this strategy (and a few more more complicated ones).

Regardless of the option you pick if you choose to hedge your gas prices, it doesn’t take a long time (your opportunity costs are low).  If you are willing to make a bet that gas is going to increase in price, it’s probably worth a few minutes of your time to make it doesn’t affect you.  Let me know what you think in the comments section…

Oil drums thumbnail sourced from www.flickr.com/photos/13951072@N00/2532628017, shot by Bradley Gordon.
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