4 Reasons To Trade Oil
Crude oil investing has several advantages over traditional equities for certain trader classes. Depending on your investment objectives, oil trading can be used for:
- Safe Haven
- Inflation Hedging
Diversify Your Investment Portfolio
Adding oil commodities to an equities-only or fixed-income portfolio can lower the overall volatility, because there is non-correlation between these asset classes. Commodities like oil are useful in countering price movements in a traditional portfolio.
Is Oil a Safe Haven?
Commodities are helpful during periods of global economic uncertainty because they tend to retain their value even during market turbulence. Investing in oil can be a strategy against exposure to loss if the market takes a downturn.
How Does Oil Act as an Inflation Hedge?
Commodities have intrinsic value independent from currency, which means they hold their value even as the value of currency falls in an inflationary environment. This is especially true of oil, given the constant and reliable global demand.
Speculating On Oil Prices
There are often wild swings in commodities prices; investing in oil futures and derivatives is a way to profit quickly from movement in oil prices, which are notoriously volatile. It’s not unheard of for prices to move 5% or 10% in a single trading session. Wall Street speculators aren’t the only ones betting on oil volatility; many major institutional traders buy oil-linked investments for their endowment and pension funds.
Perhaps the most significant advantage of trading oil is that demand is virtually guaranteed. There may be fluctuations in supply—and therefore price—but for the foreseeable future there is demand is unlikely to flatline or disappear.
Experienced traders with a high tolerance for risk can make substantial profits on low capital outlays, especially with CFDs, but also with oil ETFs and futures contracts.
The major risk with commodities in general—and oil investing in particular—is the extreme volatility in the market. The risk of loss is high, especially with derivatives, due to factors entirely beyond the trader’s control. It is not an investment for people with risk aversion, and oil trading should be just one strategy in a well-diversified portfolio.
How to Trade Oil
Trading oil requires a bit more consideration than other types of assets because there are many product choices you can use to get into the market, from pure-play oil derivatives to oil and gas company equities. Each has its own advantages and set of complicating issues.
Most oil commodities traders will choose one of the following options:
|Method of Investing||Complexity Rating (1=easy, 5=hard)||Storage Costs||Security Costs||Expiration Date||Management Cost||Leverage||Regulated|
|Buy Oil Barrels||5||YES||YES||NO||NO||NO||NO|
One of the easiest ways to start trading is with oil CFDs.
A “Contract For Difference”, or CFD, is basically a contract between an trader and a broker to exchange the difference in value between when a trade is entered and exited. Standard leverage varies, although lower-end margins are more typical. Most CFD brokers provide the facility to speculate on the price of oil futures contracts but contract sizes are typically much smaller than standard futures contracts; a crude oil CFD order can be for as little as 25 barrels (depending upon the firm) compared to 1,000 barrels for a standard futures contract.
CFD trades are frequently commission-free (the broker makes a profit from the spread), and since there is no underlying ownership of the asset, there is no shorting or borrowing cost. Oil is a global 24-hour market with constantly moving prices; it’s an ideal medium for day traders to profit from fast movement. It’s also a highly liquid market, so it’s easy to get in or out, regardless of the size of the trade.
Here’s how CFDs work: This is NOT a trading recommendation
You’re bullish on WTI, so you decide to invest in oil CFDs at the quoted price of $60.25 to $60.50 (the lower price is for a short contract, the higher for long).
To buy 10 long CFDs on 3% margin, you would need $1,815 in your account ($60.50 [long price] x 10 [number of contracts] x 100 [number of barrels in a standard contract] x 0.03 [margin percent]). You would then “control” $60,500 worth of oil for your $1,815.
That afternoon, you notice the price is up to $62.50 to $62.75, so you exit the trade, which now has a value of $62,750. You pocket roughly $2,250 on the deal. Of course, if the price ticks down, the degree of leverage works against you rather quickly.
CFDs are complex financial products, they aren’t available in the US and are only recommended for experienced traders. You will not own the oil itself.
Plus500 is one of the top brokers for oil CFD trading.
(CFD Service. 80.6% lose money.)
This is an example and not a trading recommendation.
- No commission on trades (other charges may apply)
- Free demo account
- Easy to use platform & iPhone/Android apps
- Industry-leading risk management tools
- Trade hundreds of markets with CFDs
- Your funds are safe – regulated by the UK Financial Conduct Authority
Important: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail trader accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
This is perhaps the least complex method of crude oil investing; you simply purchase equities in a company you believe will remain profitable. It’s important to keep in mind that although there is usually a correlation between the price of crude and oil company profitability, this isn’t always the case—and disasters like the BP oil spill can do serious damage to an otherwise solid investment.
Interested in oil stocks? Here are the 5 biggest listed oil companies:
|Current Price||Overview||Listings||Founded||Number of Employees||Interesting Fact|
|Sinopec||Chinese oil and gas company based in Beijing||Shanghai (SSE), Hong Kong (SEHK), New York (NYSE), London (LSE)||2000||350,000+||Largest oil refiner in Asia|
|ExxonMobil||American multinational oil and gas corporation||New York (NYSE)||1999||80,000+||Largest refiner in the World with a capacity of nearly 6m barrels per day|
|Royal Dutch Shell||British-Dutch multinational headquartered in The Netherlands||London (LSE), Amsterdam (Euronext), New York (NYSE)||1907||90,000+||Shell have over 40,000 service stations worldwide|
|BP||Headquartered in London but the USA houses the lion share of its operations||London (LSE), Frankfurt (FWB), New York (NYSE)||1908||74,000+||Burmah Oil Company, the company that eventually became BP, was the first to discover oil in the Middle East|
|Total SA||French multinational||Paris (CAC), New York (NYSE), Amsterdam (Euronext)||1924||100,000+||Total has over 900 subsidiaries covering all areas of energy|
Exchange-traded funds or ETFs are one of the ways traders can gain a piece of the oil market. You can choose funds that track the performance of oil prices using futures contracts or funds tied to a basket of oil company equities. Here are the 5 leading oil ETFs based on their assets under management:
|United States Oil Fund||iPath S&P GSCI Crude Oil Index ETN||ProShares Ultra Bloomberg Crude Oil||PowerShares DB Oil Fund||ProShares UltraShort Bloomberg Crude Oil|
A futures contract is simply an agreement to buy or sell a quantity of oil at a specified date for a specified price. These are standardized instruments for WTI and Brent that trade on the NYMEX; the standard contract is for 1,000 barrels of oil, so a $1 movement in price is equal to $1,000. Most oil futures contracts require about a 10% margin, which is rather high given the cost of 1,000 barrels of oil, although margins can change depending on volatility—don’t be surprised to get a margin call on oil futures contracts.
Futures contracts are settled by physical delivery of the crude oil, which is something most traders don’t want to deal with, so it’s important to keep track of delivery and expiration dates and either roll the position over another month or close it entirely before the contract expires.
Trading oil futures is typically for professional traders due to the high cost and complexity involved. However, contracts for difference or CFDs provide a convenient way to “access” the crude oil futures market, see below for a detailed explanation.
With oil options, an trader essentially pays a premium for the right (not the obligation) to buy or sell a defined amount of oil at a specified price for a specified period of time. Crude oil options are the most widely traded energy derivative in the New York Mercantile Exchange (NYMEX), one of the largest derivative product markets in the world
Despite their name, the underlying of these options is not actually crude oil itself, but crude oil futures contracts. Options in the oil market—and the commodities market in general—are more expensive due to the high perceived volatility of commodities prices.