Crude oil prices have been hammered of late.
The cost of oil fell 21.8% between May 1 and June 1—from $106.50 to $83.23 a barrel—the sharpest monthly drop since December 2008.
A few analysts blame disappointing economic news and stagnant U.S. demand for the short-term decline.
But most think crude has now found a bottom and will likely head higher for the remainder of the year—perhaps a whole lot higher.
Either one represents a substantial profit opportunity for energy bulls.
However, chasing those profits by investing directly in oil can be both a costly and risky proposition.
The standard New York Mercantile Exchange (NYMEX) futures contract for West Texas Intermediate (WTI) crude represents 1,000 barrels of oil, worth roughly $84,000 at this week's prices.
That means a $1/bbl change in oil prices means a gain or loss of $1,000. What's more, the initial margin requirement to purchase (or short) one contract is currently $6,210.
How to Invest in Oil Without Buying Futures
If that sounds a bit rich for your blood, don't fret - there are several alternatives to futures.
The most attractive is one of the exchange-traded funds (ETFs) designed to closely track the changes in the price of oil.
These funds can be purchased through your regular broker—no commodity account needed—and you can get in the game with a 100-share lot for as little as $2,400 (or half that if you buy "on margin"), depending on the fund you choose.
At last count, there were 20 oil-price ETFs traded on U.S. and Canadian stock exchanges, and an equal number listed on the London Stock Exchange.
But be warned, many of them are fairly new and still lack the liquidity needed to be good trading vehicles. Some are better than others.
In fact, at least four of them have enough daily volume to allow easy entry and exit points, while also offering the potential for profit regardless of which way the price of oil moves.
The two most straightforward choices for a simple bullish play on oil are:
United States Oil Fund LP (USO:NYSEArca), recent price $32.40: Actually a limited partnership rather than a true ETF, this is the most popular of the oil funds, with an average daily trading volume approaching 8 million (M) shares. The managers invest the partnership's pooled assets in a variety of vehicles, from oil and gas futures and forward contracts to cash-settled energy options, the goal being to match the performance in percentage terms (less expenses) of the spot price of WTI crude.
With assets totaling about $1.42 billion, USO's shares are currently trading at a modest discount to their net asset value (NAV) and stand near the low end of its 52-week range of $29.10 to $42.30. Oil's range over that same period has been $77.40 to $111.49 a barrel. USO's average return over the past three years has been 10.53%, but short-term traders have had numerous opportunities to take larger gains during that period.
PowerShares DB Oil Fund (DBO:NYSEArca), recent price $24.50: This fund is more narrowly focused, using investments in futures over various time frames to track the price and yield performance of the Deutsche Bank Liquid Commodity Index, which is structured to mirror the percentage change in WTI crude prices. DBO is less actively traded than USO, with an average daily volume of just under 500,000 shares, but should offer sufficient liquidity for most trades.
With assets totaling around $755M, DBO is also trading at a small discount to NAV. The 52-week range of share prices has been $22.07 to $32.06, and the average return over the past three years has been 15.84%.
Two More Ways to Play Oil Prices
For investors more aggressively bullish on oil and looking for larger gains, the top choice would be:
ProShares Ultra DJ-UBS Crude Oil (UCO:NYSEArca), recent price $28.77: This fund tracks the Dow Jones UBS Crude Oil Sub-Index, which reflects the price of WTI crude oil as measured by the price of NYMEX futures contracts. However, it uses leverage in the form of swaps, forward contracts, options and futures to seek percentage results roughly twice as large (200%) as the changes in crude itself.
This is the most popular of the leveraged funds with an average daily volume of 1.35M shares. The effects of the leverage are evident in the more volatile trading range, which has spread from $24.58 to $49.96 over the past year. With $262M in assets, UCO has provided an average return of 12.84% over the past three years.
Finally, if you think the analysts are wrong and the recent drop in oil prices is just the beginning of a bigger pullback, you might want to consider a so-called "inverse ETF." The most popular one at present is:
ProShares UltraShort DJ-UBS Crude Oil ETF (SCO:NYSEArca), recent price $50.17: Like UCO, this fund tracks the Dow Jones UBS Crude Oil Sub-Index, but it invests in short futures positions and put options in an effort to produce a daily return twice as large (200%) as the percentage drop in oil prices.
In other words, when oil goes down, SCO's share price goes up— by twice the percentage. This is evident in SCO's current price, which is closer to the $71.36 top of its 52-week range than the $30.74 bottom, reflecting oil's recent drop. SCO is up 53.1% since May 1 and 35.4% year to date; however, its average return over the past three years has been well into negative territory. The fund has roughly $170M in assets and an average daily volume of 1.4M shares.
Larry D. Spears