How to Trade Oil ETF Volatility


"Few investors realize it, but the oil ETFs give investors a monthly opportunity to make day trading profits on senior oil stocks."

The United States Oil Fund (USO) is now so large, it contains more than 20% of the outstanding March crude oil futures contracts (West Texas Intermediate, or WTI). Now, being an ETF, it does NOT want to take physical delivery of that oil. So on the 5th, 6th and 7th business days of the month it rolls over their entire set of contracts to the next month putting undue, abnormal pressure on the oil price those days. The Goldman Sachs Commodity Index does the same thing every month, but on the 6th, 7th and 8th business days.

BetaPro Horizons, which operates the Canadian oil ETFs, symbols HOU and HOD, say they roll over their Light Sweet Crude Oil Futures contracts on the 7th, 8th and 9th business days, but claim their holdings are so small compared to the other two that there would be no impact in the markets from their activity. Still, it would likely accentuate the already abnormal pressure.

Trading for the WTI contract is open 01:00 London (local time). The close is at 23:00 London time, except Monday morning when the open is 23:00 London time. In other words, well before stock markets open for trading, investors can see what the futures are doing, and will often react to their direction.

Savvy investors can potentially benefit from this event by buying senior oil stocks, whose performance tends to mirror the oil price almost exactly, with timely at-the-market orders, just as other investors react to the pre-opening WTI futures contract price down-tick as "forced" selling by these ETFs takes place. They can either do this ahead of the anticipated price pressure by selling their stocks at the close the day before, and/or by buying these stocks during the spike-down opening trade. Really aggressive investors may take advantage using the underlying options on these stocks - a tougher trade requiring precision timing and loads of experience.

These ETFs are getting very popular, and are so large that they are having an increasingly large impact on the market. Reuters reports that USO has increased in size 400% just since early December.

This is an example of the crazy derivative trading that Warren Buffett warned us about years ago, and what brought down the world's financial system last fall (think CDS Credit Default Swaps).

But this is our current reality. Obviously, this trade is for sophisticated and/or brave and/or crazy investors. But if you are a good day trader, it could represent an opportunity for quick profits.

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