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May cover


Using put options to manage supply-side risk
Cost Management Solutions    
Cost Management Solutions


Propane prices have been choppy in recent weeks. They move up one day and down the next. Part of the volatility is related to volatility in crude prices. However, the volatility has also been caused by divergence in the long-term view for propane prices relative to the recent fundamental data. While far from the consensus, many believe the longer-term prospects for propane prices are more bullish than bearish.

However, propane inventory is currently only slightly below the record high for this time of the year. Plus, over the last two weeks, propane inventories have built at a well-above-average pace. The dichotomy between the long-term upside risk for propane and the short-term fundamental conditions makes it very difficult for propane retailers to be confident propane supply buyers. When conditions are uncertain, a retailer should always consider options as a way to manage supply-side risk. The focus of this Trader’s Corner will be on how to use put options.

Propane retailers are most concerned with rising prices because they are generally “short” of the product they will need to sell. That is why taking storage positions, buying swaps and establishing pre-buys are among the most popular hedging tools for retailers.

However, once those positions are taken, the risk shifts to falling prices. If prices fall, retailers worry about getting into an uncompetitive situation. If competitors have not taken similar “long” positions, they will be free to lower prices in a falling market. Eventually, a retailer that is long may come under pressure to lower prices to retain customers, thus taking a hit to margin and profitability.

In general, when retailers take long positions (swap buy, storage, pre-buy), they expect prices to rise; otherwise those long positions probably wouldn’t be taken. However, it is not uncommon for retailers to see those long positions be positive for a while, only to have market conditions change and any gains be lost. If at any point after buying a long position retailers want to protect gains or keep a long position, but nevertheless have become concerned about falling prices, they should consider a put option buy.

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The put option will offset losses to the long positions and allow retailers to lower prices in order to remain competitive. It is common for retailers to take long positions throughout the summer and then in the fall buy put options to protect gains on those positions. Once fall arrives, it becomes a bet on winter demand, and that is generally a 50/50 bet on whether prices will rise or fall throughout winter. By holding a long position and a put option, retailers are indifferent to which way the market moves. The long position will protect them from rising prices, and the put option will protect them from falling prices.
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Of course, put options transfer risk and no one is going to relieve a retailer of the risk for free. Put options have premiums, an expense that's added to supply costs. But establishing a known supply-pricing structure – regardless of price direction – may be well worth the investment in the put premium. A retailer using put options to cover long positions can find themselves getting amazingly good sleep even in the most turbulent propane supply pricing environments.



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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.

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

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