[click on word for definition]
- Benefits of Using Options - The crucial argument for using options to hedge risk is that the cost of the hedge is known up front (the option premium). After that, the option buyer cannot suffer any additional loss. Compare this to hedging with a physical pre-buy or a swap contract, where losses on the hedge can grow to surprisingly large amounts in a hurry, and must be monitored carefully.
Essentially, buying an option is a way to simplify the task of managing risk for a known and upfront fee, freeing up time and resources to devote to your core business.
- Swaps - Swap - a financial contract between two parties in which the buyer receives payment from the seller if the price increases, or the seller receives payment from the buyer if the price decrease. No actual propane changes hands, just a money settlement based on the direction of price over the term of the contract. A swap simulates the financial gain/loss of taking a position in physical propane, but without the added expense of transacting the underlying product.
- Puts - Put Option - A Put Option is just like a Call option, only a Put option will pay the option buyer when prices fall BELOW the strike price. Put options are used to hedge the risk of FALLING prices, such as the case where propane supply costs are locked in before the retail sales price is determined (fixed-price supply but a floating sales price).
- Call Option - a Call option is used to hedge a company's risk to RISING prices. It can best be explained by comparing it to an insurance policy. Take an automobile insurance policy for example: you pay a premium to secure coverage for your car. In return, the insurance company will pay you a settlement if certain events come to pass - for example if your car is wrecked or stolen.
In much the same way, you pay a premium for a call option. In return, the option seller pays you a settlement if prices settle above a certain number - that number is called the option "strike price." The strike price can be any price you choose, keeping in mind that the lower the strike price, the higher the premium. Call options allow the option buyer to collect money in a rising market, without suffering losses in a falling market. They are an easy way to hedge the risk associated with "price cap" programs offered to retail customers.
- Collars - Option Collar - an option strategy in which the buyer of an option will simultaneously sell a different option to reduce the net premium paid, in exchange for some added risk. A common example of this would be where the buyer of a call option will also sell a put option (the put usually has a strike price this is much lower than the current propane price). Selling the put option has the effect of lowering the net premium paid for the call option. The buyer of the collar now has the benefits of the call option at a lower premium. However, the collar buyer also has some downside risk if the market falls dramatically.
We don't believe that Price-Risk Management is just
reducing exposure - we find opportunity.
Working directly with our customers offers us the unique opportunity to help maximize profit and reduce risk and exposure. Alliance Energy Services approach to supply-security is PLANNING. We incorporate risk-management strategies with a supply plan specific to our clients' retail operations.
We take the speculation out of the game of propane procurement and supply our customers with a customized approach THE PLAN that helps maximize profits and achieves financial goals.
Today's highly volatile propane market presents new challenges to retail businesses. Rapid price movements of greater than 50 cents per gallon - once unheard of - are now becoming part of the seasonal landscape in propane wholesale markets. As a result, retail propane marketers are now exposed to more risk to their bottom line margins than ever before.