Is UGA at the top of its range?

by Jay Pestrichelli on August 7th, 2012

We haven’t written about gasoline for 2 months mostly because there was nothing to write about. But now looking at a chart of the last two years, and new story emerges.  As a general proxy we use the ETF UGA as a means of tracking the price of the commodity, and here is the chart as a reference.
Looking at the price of Aug 2011 and Aug 2010, and the current UGA price is notably higher.  One year ago, the price was $46 and 2 years ago $35 compared to today’s price of $56.6.  Since March 2011, UGA has traded in a range between 46 and 58 and historically it has been generally accepted that gasoline trades with a high correlation to oil. However mapping UGA against Crude Oil futures shows there has been a divergence of the two assets.
An article on Seeking Alpha from Sunday titled: Buy Gasoline Futures to Profit From Storms and Florence attempts to explain the move due to the challenges of two potential hurricanes as well as the prolonged impacts of the season.

If oil continues to rebound or the hurricane season brings more supply disruption than expected, UGA may continue to rise to through its high of April 2012.

On the flip side of the discussion is that UGA has outpaced actually gasoline futures that it is based on. In the below chart of the last 12 months, we can see that UGA is up 23.5% compared to actual gasoline futures that are only up 9.6%.
As UGA is calculated from multiple expirations of gasoline futures, we can see that there are higher expectations for the price of gasoline a few months out and that is causing the ETF to outperform both gasoline and crude futures. In other words, the impact of weather and potential oil price hikes has already started to work itself into UGA and in our opinion, has happened too fast.

Bottom line, if you’re trading UGA, consider a hedged position that would benefit from a retracement in UGA in advance of any potential pullbacks in oil. That could be a short protected with a long call or a bear put spread. Either way, going bearish at the top of the range with protection, can be a good trade in the near term of 2 to 3 months.

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