Black gold, Texas tea. You know the song and you’d like to be an oil tycoon yourself, or at least include oil investments as part of your trading strategy. However, stocking up on barrels of oil in your garage is not only an inefficient method of stabilizing your portfolio, but a fire hazard as well. There is an alternative to investing in oil without becoming the neighborhood gas station.
What are Oil ETFs?
Enter Oil ETFs. Oil commodity exchange traded funds are a simple way to expose your investment strategy to the price and performance of oil, without actually owning any oil itself. Oil ETFs consist of either oil company stocks or futures and derivative contracts in order to track the price of oil, or in some cases oil-related indexes.
For example, one of the most popular oil ETFs is USO, the United States Oil ETF. In the case of this particular oil ETF, you do not actually own the oil; the fund consists of futures, options and forward contracts for different oils, gases, and petroleum based-fuels. So you have exposure to the price of oil, but you don’t have an actual oil rig gushing in your back yard.
Why Should I Buy an Oil ETF?
The other nice thing about oil ETFs is the simplicity of the trade. If you wanted to invest in the oil industry, you would have to make individual purchases of oil company stocks. And then there is the decision of which companies to choose. And even if you decided to invest in an oil index such as the OSX, there is still the challenge of purchasing all the equities in the index basket in order to target a certain price. Complications and commissions make it hard to achieve your investing goal.
However, in the case of an oil ETF, like the OIH (which tracks the OSX Index), you make one purchase at one price and save on commissions. The oil ETF is already bundled ahead of time. With one trade, you have instant exposure to the price of oil.
What are the Benefits of Oil ETFs?
When you consider an oil ETF for your portfolio, the nicest attraction is the advantage it creates for an investor. Capital gains taxes aren’t incurred until the sale of the fund, giving ETFs huge tax advantages over other investments such as mutual funds.
There is also the added benefit of having an easier trade and lower fees among the many other advantages of ETFs. Not that there aren't some limitations when trading ETFs, but if you understand how they work, ETFs could be a great addition to your portfolio.
What are Some Strategies for Trading an Oil ETF?
If you are looking to stabilize some oil investments in your portfolio, with one trade you can sell an oil ETF and help reduce your downside oil risk.
You can also use oil ETFs to hedge to downside risk for both industry and foreign investments. If you are long a lot of oil stocks, sell an oil ETF to hedge your downside risk. Do you have foreign investments in a country where oil is a major source of income? This would be another opportunity to sell an oil ETF to protect downside. And there is the option of purchasing an inverse oil ETF which tracks the price of oil or an oil index in the opposite direction. Inverse ETFs are perfect for investors who want to short oil, but can't sell ETFs due to margin or account restrictions.
There is also another strategy to protect your oil ETF investments. If you don’t want close your ETF positions, but want some short-term exposure or protection, trading oil ETF options can be a sound investment.
How Do I Invest in Oil ETFs?
If you’re ready to trade oil ETFs as part of your “slick” investment strategy, make sure to conduct thorough research first. Track the performance of the price of oil and watch how some of the major oil ETFs react to different market conditions. Once you have a good feel for the commodity, you can get started by including oil ETFs and ETNs in your investing arsenal.
Or if you prefer, here is a List of Energy ETFs.