Hedging Rising Oil Prices 2/25/12

The company I work for got hit with several million dollars of higher material prices on plastics last year. That made me think about how the company could reduce this volatility and have more predictable performance results based on manufacturing operations only.

Plastics is made from oil. When oil prices rise, so do prices on a wide range of plastics. So why not hedge oil? Sure, that would be quite easy to do with oil futures. People who are in the agricultural business do that with crop futures. So why not hedge oil for rising plastics prices? Buying a hedge against a known position lets you stay neutral to the price of the material as it stands now at a future point in time. When oil prices rise, the oil futures price would also rise. My understanding is that our company does take a hedge on a material that we consume in large quantities. That is good but there is a better method.

Using dynamic hedging techniques, I could stay long on oil futures as long as the price of oil was rising. When the price of oil starts dropping, it would be better to drop the hedge and let material prices decline and increase company profits when plastics become lower in price. The only catch is that most financial people do not know how to do dynamic hedging. Maybe one day I could do this for our company and for others but in the meantime, I could practice this on the family portfolio and finances. Our family uses gas for the two cars we have and gas prices are rising. So why not practice dynamic hedging on it?

The hypothesis is: I want to be hedged against rising gas prices and not feel any negative affects.

I am tracking two ETFs for oil; one being OIH and the other USL. I am long in my position of OIH and have already generated enough profits to fully offset a potential rise in oil prices for the next several months. When I see the system generating an over bought situation or generates a down signal, I will exit.

Meanwhile here are the charts of OIH and USL with a trading system I am using on them signaling when to go long and when to exit.