Learn About Crude Oil ETFs and How to Invest

Leveraged ETF Description
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Black gold, Texas tea. Oil can translate into big money, and maybe you’d like to be an oil tycoon yourself or at least have oil investments as part of your trading strategy. Stocking up on barrels of oil in your garage, though, makes for an inefficient method of portfolio diversification and a fire hazard as well.

You can begin safely investing in crude oil without becoming the neighborhood gas station, by learning some background on and investing in crude oil exchange-traded funds (ETFs).​

A Quick ETF Primer

Oil commodity exchange-traded funds provide 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 that 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, without buying up any barrels of the actual stuff.

Why Buy an Oil ETF?

Oil ETFs take all the extra work out of investing in oil. Typically, if you wanted to invest in the oil industry, you would have to make individual purchases of oil company stocks. You would also be burdened with the decision about which companies to choose.

Even if you decided to invest in an oil index such as the OSX, you would have the challenge of purchasing all the equities in the index basket in order to target a certain price. Complications and commissions would make it quite difficult 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, and with one trade, you have instant exposure to the price of oil from a variety of securities.

The Benefits of Ownership

When you consider an oil ETF for your portfolio, you'll enjoy advantages from a tax perspective. Capital gains taxes aren’t incurred until the sale of the fund, giving ETFs huge tax advantages over other investments such as mutual funds.

You'll also have the added benefit of easier trading, because you can get in and out of ETFs at any point since you trade them directly as you would the stocks in your portfolio, instead of having to go through a broker-dealer or mutual fund company.

You'll pay lower fees as compared to a mutual fund, and you can short ETFs, use limit and stop-loss orders, and apply any trading strategies you'd like as you add ETFs to your portfolio. 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.

Strategies for Trading or Diversifying

Since you can trade oil ETFs like you would individual stocks, this opens them up to all sorts of strategic trading options. For example, if you want 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 the downside risk for both industry and foreign investments. If you hold long positions in several oil stocks, you can sell an oil ETF to hedge your downside risk.

Do you have foreign investments in a country that has oil as a major source of income? This would be another opportunity to sell an oil ETF to protect you from downside risk.

You also have the option of purchasing an inverse oil ETF which tracks the price of oil or an oil index in the opposite direction. Inverse ETFs make sense for investors who want to short oil, but can't sell ETFs due to margin or account restrictions.

One more strategy can protect your oil ETF investments. If you don’t want to close your ETF positions, but want some short-term exposure or protection, trading oil ETF options can be a sound investment.

Making an Investment

If you’re ready to include oil ETFs as part of your investment strategy, conduct thorough research first by tracking oil prices and then pay attention to 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. Here is a list of major oil ETFs to consider for your portfolio, and a list of short oil ETFs. Or if you prefer, here is a list of energy ETFs.