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Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business or drop us an email at info@propanecost.com.

Trader's Corner

This week’s Trader’s Corner looks at covering short-term volatility using call options.

If you will recall two weeks ago, we went through the mechanics of a call option and how to use it to set our retail price. Click here to review that Trader's Corner. In that discussion, we used call options to protect us through the end of the year. To do so, we would have bought a call option for October, November and December.

What we want to do this week is narrow the discussion to a one-month call option. Our focus is on the advantage a retailer would have had during the month of September if he had been holding a call option. The chart below will establish the parameters for our discussion:

To begin the discussion for the September call option, we really have to start in August. Look at how much propane prices had gone up during August. Belvieu had added 21.625 cents and Conway 21.813 cents.

Now think about how you were feeling during August. If honest, most propane retailers will tell you they were feeling pressure to buy. The propane inventory trend was flat to lower and there was plenty of talk of exports pulling inventories down more.

So what do you normally do to protect against higher prices? You buy a pre-buy, buy a swap and/or fill up storage facilities. We suspect many of you did one or more of those things during August. When you did, you eliminated the risk of higher prices, but you assumed a new risk. Once those positions were taken, you were at risk to falling prices.

Well, of course, seemingly against all logic based on what was going on during August, propane prices fell during September. Through Sept. 25, if we did any of the things we normally do to protect from higher prices, we were down 15 cents if our supply was based off Belvieu and 16.875 cents if our supply was based off Conway.

What is more, the volatility could have had us moving in and out of positions, and unless we timed it right we could have even compounded our losses. So, if we did any of the three things above during August to protect against higher prices during September, one of two things has happened. We have had to hold our street price high to protect margin and in doing so risked losing customers because our competitors (who did nothing, of course) are lowering their street price. Or we have lowered our price to remain competitive and, in so doing, took a hit to our margin.

Now let’s look at how this would have played out if at the end of August we had purchased a September call option. On Aug. 26, some of our clients bought September Belvieu call options at a strike of 112.25 cents and paid a premium of 3.75 cents.

From our table above, we see the monthly average so far for September is 111.3472 cents. The strike on the option is 112.25 cents. If the monthly average is below 112.25 cents, the option expires without us getting paid anything. That is the likely outcome in this case. Some would say the option expired worthless.

But was it really worthless even though it didn’t pay us? Doing absolutely nothing during August to protect against higher prices for September would have turned out to be the best choice. A retailer who did nothing in this case beat the retailer who would have paid 3.75 cents for a September call option.

However, compared to the alternatives of pre-buys, swaps or filling storage, the call option would have been a better choice. Remember we would be down 15 cents on those choices compared to the 3.75 cents of the option. The important thing is that once we have priced the 3.75-cent cost of the call into our street prices we are free to move lower if prices fall.

If prices had gone higher, the option would have protected us. But it also allowed us to be more competitive in a falling market. It is true that in this falling market we are 3.75 cents above our competitor, but had we taken any of the other steps our street price would have been 15 cents above the competitor.

Remember our goal is to always have competitive supply. In this case, we would have remained in a much more competitive position having chosen the call option over pre-buys, swaps or filling storage.

Buying call options to protect the upcoming month is an excellent way to make sure of a competitive supply position. For a relatively small premium (compared to market volatility), we can protect our customers from higher prices and most importantly market blowouts, and we can remain competitive in falling markets. The most important of all is that no matter what direction prices go we know we won’t have to sacrifice margin to remain competitive.

In fact, the opportunity to make more margin is present if we hold a call option. Obviously, if prices go up and our competitors are raising their street price because they were unprotected, our margin opportunity improves. We can follow them higher, make our budgeted margin, plus pocket the gains on the option, or we can use the option to cap our street price, giving our customers the benefit of the option protection.

Likewise, if your competitors buy pre-buys, swaps or fill storage and prices fall, they will need to hold their street price up to avoid a margin hit. We can keep our street price with them, and since the price to our normal supplier is falling we could make more margin despite the premium cost on the call.

For example, September propane is down 15 cents, so we are paying 15 cents less than what we did in August for supply. But if our competitors filled storage instead of using an option to protect against higher September prices, his cost of supply is still at August prices. So he needs to keep his street price where it was in August. If we also hold our street price where it was in August, we will make 11.25 cents more than we expected (15-cent drop in physical supply cost minus cost of option of 3.75 cents).

Depending on how our competition was positioned, the best scenario just might be for our option to expire “worthless.”

If we correctly predict market direction, doing nothing or buying pre-buys, swaps or filling storage can beat a call option. But, on the other hand, if we guess wrong, those other choices can really hurt us. By holding call options, we should never be uncompetitive, and we will have an increased chance of making higher than our budgeted margin in many cases. Of course, everything is relative to the premium cost of owning the option, but is never a bad idea to price them out and consider them relative to other supply management choices.

Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.


WEEK IN REVIEW
The risks remain to the downside for crude, but propane was showing signs of life on Thursday and Friday. We begin the week neutral though, needing confirmation that what we saw to close the month can carry forward.

LAST WEEK'S DAILY HIGHLIGHTS
Monday: Propane prices remained in a surprising downtrend and crude went lower as traders worried less about Middle East supply issues.

Tuesday: Propane prices continued to fall at a quick clip despite the previous week’s reported inventory draw. A slip in consumer confidence helped keep crude in its downtrend.

Wednesday: An above-average build in U.S. propane inventory sent prices down sharply. Crude moved lower on a 2.6-million-barrel build in crude inventory and worries about the U.S. federal government budget issues.

Thursday: It was a bounce-back day for propane as prices increased slightly, outpacing crude to the upside. Crude saw opportunity buying or possible short covering that caused a slight increase in prices, but the bounce didn’t appear to have much depth.

Friday: Propane prices experienced a quick bounce midmorning on what some said were large institutional players working the front and back ends of the propane price curve. Today’s action was to buy the front (September and October), which caused the bounce that played out about as quickly as it began, though much of the gains held.

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COST MANAGEMENT SOLUTIONS
Cost Management Solutions LLC (CMS) is a firm dedicated to the analysis of the energy markets for the propane marketplace. Since we are not a supplier of propane, you can be assured our focus is to provide an unbiased analysis.

Market Information Services
The Propane Price Insider, an e-mail service that provides:

  • Three Daily Price Flash Wires
  • Periodic Option Quotes
  • Wednesday Inventory Data Updates around 11 a.m. ET
  • Evening Report with Executive Summary, Trader's/Hedger's Corner, Weather maps and complete review of energy prices that are based on Propane's Btu Equivalent

Free trial!
For a free 10-day trial subscription by e-mail, sign up online here or call toll-free at 888-441-3338.

Client Services
Many retailers simply don't have time to analyze the large amounts of data to make an informed purchasing decision.

We offer:

  • Detailed market recommendations on hedge and pre-buy entry points
  • Prompt market execution of hedging strategies
  • Supply cost analysis and recommendation as to effective hedging strategies
  • Because of the volume of transactions we place annually, we receive large volume consideration when we place your hedges

Visit us online at www.propanecost.com. Or e-mail info@propanecost.com.

Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.

Dale G. Delay 888-441-3338, ddelay@propanecost.com
Mark Rachal  318-865-9928, mrachal@propanecost.com

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