Consumers are loving the price of gasoline right now.
[ad#Google Adsense 336×280-IA]Thanks to plunging oil prices, the cost to fill up your tank is down 25% over the past year and down by almost half over the past two years.
If you’re the average American driving 13,476 miles a year and getting, say, 20 miles per gallon in your new Ford (NYSE: F) F-Series pickup, the best-selling vehicle in America for decades, you saved more than $370 in the past 12 months.
But these ultra-low gasoline prices aren’t likely to last forever. Just look at the chart of pump prices over the past 10 years:
It resembles the Himalayas with massive crevices and jagged peaks, and we’re about to move into one of the most expensive times of the year to fill up your tank.
Summer is Coming… Along With Higher Prices at the Pump
There are plenty of fundamental reasons why oil prices could soon be increasing and drive gasoline prices higher. Rig count in North America has fallen 56% in the past year, while OPEC members and Russia are discussing a production freeze.
But even if oil prices remain low, the summer is historically a time of rising gasoline prices.
The summer driving season kicks off Memorial Day. Last year saw 37.2 million people driving 50 miles or more over the holiday weekend — the most in a decade. And between February and May of last year, the average price of a gallon of gas shot up more than 22%.
If history repeats itself, those who get in front of the trend stand to benefit.
Futures traders are already betting on higher prices this year. The front-month March contract for gasoline is priced at $0.97 per gallon, while the June contract is $1.26 per gallon.
The United States Gasoline Fund (NYSE: UGA) is designed to track the percentage change in the price of gasoline by investing in the front-month futures contract on the NYMEX. The fund invests in futures contracts of reformulated gasoline blendstock for oxygenate blending (RBOB) and other gasoline-related contracts.
In theory, UGA can’t perfectly match the percentage change in gasoline for two reasons. First, the management fee will reduce assets by 0.6% annually. This is higher than some passively managed index funds but still fairly low for an active fund.
The more important difference between the fund and actual gasoline prices comes from something known as the roll spread. The fund must continuously buy new futures contracts as the front-month contract expires. Most of the time, the futures market is in contango, which means that prices increase the further out on the futures curve you go.
In reality, the fund has tracked the fall in energy prices extremely closely and should be able to provide protection from higher prices at the pump on the way up as well.
UGA peaked in June near $43, beginning a slide that took it to a seven-year low last week just above $20. However, it spent most of 2015 trading above $30, and I think it could potentially reach this level again as we head into the summer driving months.
My plan is to get positioned now using a covered call strategy, which involves buying at least 100 shares of the ETF and immediately selling a call option against the position. The call option obligates you to sell the shares at the option’s strike price if they are above that level when the option expires. In return, you receive a payment, which is known as a premium.
The income received from selling the call option is yours to keep no matter what. If the stock declines, your shares will decrease in value, but you have the option premium to counter the loss. In other words, if shares do happen to fall, you’re better off selling a covered call than simply holding the fund.
With UGA trading at $22.26 at the time of this writing, we can buy 100 shares and simultaneously sell one UGA July 28 Call for around $0.85 ($85 per contract) for a net cost of $21.41 per share, which is almost 4% below the current price. I like this trade as long as you can enter for a cost basis of $21.55 or less.
If UGA closes above the $28 strike price at expiration on July 15, our shares will be sold for that price. In this case, we will make $5.74 in capital gains, plus the $0.85 premium we collected for selling the call, for a total return of $6.59 per share. This represents a profit of 30.8% over our cost basis of $21.41. Since we’d earn that in 148 days, it works out to an annualized gain of 76%.
If UGA closes below the $30 strike price, we keep the premium and the shares and can sell more calls to collect even more cash on the position.
— Joseph Hogue
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Source: Profitable Trading