The USO chart and ETFs

Pip pip good chap! Why, ETFs are a way to trade oil if there ever was one! Trading is only a click away and nobody has to worry about being stuck with barrels of the black stuff if futures expire. There are more advantages as well. Allow me to expound.

Liquidity

Some ETFs are more popular than others, so much so that they are traded in the millions and making it easy to jump in and jump out where you want.

Leverage

ETFs are funds that attempt to follow the markets. These funds are filled with all kinds of stocks or futures or whatever that makes them behave in certain ways. For example, UCO is an ETF that tries to double the daily price movement of west texas intermediate crude. Imagine that…oil moves 2% and your ETF moves 4%! There’s more…SCO is an ETF that attempts to move double the OPPOSITE of the daily price movement of oil. So oil is down 2% and SCO is up 4%. You can even find ETFs that go for triple the daily price movement.

Variety

Here is a great list of ETFs that deal with oil:

List of ETFs
Courtesy of etf.com. Click on the image to check out their list.

A few disadvantages to having ETFs are that, while they attempt to follow the price of oil, they aren’t oil. Their prices move close but never the same. In fact, one big problem that ETFs have is contango.

Contango

What in the world is that? Here’s what nasdaq has to say about it:

The Contango Problem

While this process of continually rolling over futures contracts may seem like a great way to track the price of crude oil, there’s a practical problem with the method: contango. The rollover method would work perfectly if oil funds could sell their expiring contracts for the exact same price that they pay for the futures contracts they buy each month.

However, in reality, it’s often true that oil futures contracts get more expensive the farther their expiration date is in the future. That means that every time the oil ETFs roll over their contracts, they lose the difference in value between the contracts they sell and the contracts they buy.

Read more: http://www.nasdaq.com/article/think-twice-before-buying-a-top-oil-etf-cm433169#ixzz4QeqQe8Rt

And here is what it looks like:

contango-in-uco

As you can see, for this ETF, back in January 2015 it would have had to be at $42 to match oil’s $50 mark. If you bought it then and held it until October 2016, the price of oil would have to increase to about $210 for you to break even! Obviously some ETFs are for short term moves…the shorter, the better!

There is one fund that attempts to tackle the problem of contango. USL is set up in such a way that it tracks the price of oil but without the contango problem. The result is a fund that more closely follows west texas intermediate.

One way to profit from contango is to short the ETF that is suffering. If you had shorted this ETF back in January 2015 and covered your position in¬†October 2016, you would have earned about 75%, even with the price of oil unchanged. Of course that doesn’t take into consideration the fees involved (see the expense ratio column in the upper chart).

I use the chart for the USO etf. I find that, as long as you keep in mind where $50 is, the trends are easier to spot that with the crude chart.

Do be careful young lad

Remember that any trade you enter is your responsibility and if you are buying or selling on margin you can lose more than you invest. Consult with a professional financial advisor if you aren’t sure about anything. And know that I am not a professional financial advisor.

Enjoy trading and good luck!