Sunday, June 8, 2008

How to protect yourself from rising gasoline prices with hedging?

The last couple of months have been devastating for consumers with gas breaking through $4 across the country, thus triggering increases in essential items such as food and transportation. The increase in gasoline is directly correlated to the relentless increase in the price of oil, which has risen almost 14 fold since its lows in 1999. On Friday, the price of oil rose to yet another record high. News reports claim that the only reason why gas prices are increasing is not due to actual supply shortages, but due to speculator activity in the futures markets. Never the less important price levels are being broken. $3, $4 we might even see $5/gallon very soon.
So how can you protect yourself from rising gasoline prices?
One way is through conservation. Try commuting to work or school with friends. Use a bicycle for short distances or simply to walk to your destination. This would decrease some of your gasoline usage, but not all of it.
A smart way to protect yourself from rising gas prices is by hedging your annual usage using one ETF. A hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. The ETF is UGA- United State Gasoline Fund L.P. It trades on the NYSE just like any other stock like Microsoft, IBM or Apple. This fund owns futures contracts on gasoline and thus is able to track the daily movements of gas prices pretty closely.
In order to take full advantage of UGA try to determine your gas usage for a year, multiply it by the current price of gasoline and then determine how many UGA shares you should buy to protect yourself for one year.
In other words if I use 10 gallons of gas per week, that translates into 520 gallons per year. At $4/gallon my annual gasoline costs would equal $2080/year. Based off of UGA’s closing price of $65.78/share on Friday, I would need about 32 shares in order to be fully hedged for the next one year. Of course you can hedge your exposure for more than one year or even hedge only a part of your expected gas usage.
If you are interested in protecting yourself from future gas price increases by purchasing UGA, consider opening a brokerage account with Zecco Trading. If open it with at least $2,500, you will receive 10 free stock trades every month.
If you don’t have $2,500 to open an account, then consider trying out Sharebuilder, which offers low commissions and also allows you to buy fractional shares.

4 comments:

  1. Dividend Growth Investor - I enjoyed your post. I like how you explained how to hedge against the price of gas. I will be looking into that for sure! Thanks for the help!

    ReplyDelete
  2. Oh yeah - forgot to mention that I added you to my blogroll.

    ReplyDelete
  3. P F I,

    Thanks for your kind comments and for stopping by!

    ReplyDelete
  4. Wouldn't you attribute rising gas prices to the value of the dollar as well?

    ReplyDelete

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