Prelude to "Driving Season" often spells opportunity for Gasoline Put Sellers

By: James Cordier, Michael Gross, OptionSellers.com

March 1, 2010

One of the more enticing factors of investing in commodities is the seasonal nature of supply/demand cycles in certain markets. Nowhere is this demand cycle more pronounced than in unleaded gasoline.

If you live in the Northern Hemisphere, you may have noticed that you often pay more for unleaded gas during the summer months. This is not due to coincidence nor is it due to any magical formula set forth by oil companies. It is basic supply/demand economics. The northern hemisphere summer brings with it what has come to be known as "driving season" in the US and Europe. With warmer weather and kids out of school, the public is more apt to travel. This typically creates a surge in gasoline consumption at the retail level, which in turn, has tended to drive up prices at the pump beginning in May and peaking during the July/August time period.

May Unleaded Gasoline (RBOB)

Yet a cornerstone principle of seasonal analysis is that price tends to precede consumption. Thus, while prices at the pump will tend to rise during the summer months, demand at the wholesale level tends to begin rising early in the year as distributors begin to build gasoline inventories in order to have enough supply on hand to meet summer driving needs. As wholesale prices are what is reflected on the NYMEX futures contract for unleaded gasoline (RBOB), this is where you as an investor should place your focus.

Sometime in the late February/March time period, refineries begin to shut down for maintenance as they switch over from distillate (read heating oil) production to focus on unleaded gasoline production. This in and of itself can temporarily reduce production and crimp short term supplies. Yet, it is the seasonal wholesale demand (and the anticipation of it) that tends to carry uptrends in RBOB gasoline prices through springtime. Thus, in the past, prices on the wholesale level have tended to rise in accordance with this increase in commercial demand (caveat: Past performance is not indicative of future results.) Bears pointing out that crude and unleaded are currently "oversupplied," take note: Supplies are often at their highest points of the year right now as demand is at a low point. In addition, cyclical tendencies tend to occur regardless of the outright supply of gasoline.

US Gasoline stocks tend to fall off in February and March as refineries shut down for maintenance and then slowly build into June when retail demand season begins in earnest. Prices tend to rise throughout springtime months as wholesale demand surges. (Chart courtesy of Hightower Research)

Of course there are other factors that influence the price of gasoline. However, during the first half of the year, they are set against the backdrop of this rising Northern Hemisphere demand. This seasonal demand alone can often be enough to underpin gasoline prices through the Springtime months.

Investors willing to give up the "home run" may consider the high probability income strategy of put selling on unleaded gasoline (RBOB) contracts. This strategy can be particularly effective in the futures markets given a fundamentally supported commodity.

A strengthening dollar or a darkening US economic tone would be bearish factors to consider for gasoline investors while the reverse would strengthen the bullish argument. However, energy prices firming over the past few weeks in the face of a rising US dollar may be an early indication that cyclical demand is already being anticipated. Dollar weakness late this week helped put an exclamation point on a strong month for energies.

Investing in a warm weather play may seem counterintuitive as you watch the snow pile up outside your window. In addition, seasonal price movements are in no way guaranteed and can be inexact in their timing when they do occur. However, one may be wise to bank on the fact that Americans will once again take to the highways when milder weather inevitably arrives and that gasoline distributors will begin preparing for the surge in demand now.

While our macro-economic view is weighted towards call selling in commodities at this time, gasoline is one market where put sales could be the highest probability play. We would see weakness over the next two weeks as opportunities for adding to short put positions.

To learn more about selling options in the commodities markets, feel free to contact us. A complimentary option selling information pack is available for qualified investors.