Figuring out whether oil ETFs have a place in your portfolio can be tough. You probably already know that the price of oil fluctuates and that the rise of alternative energy market parity with oil makes oil a much riskier proposition for an ETF than before.
In this article, we’ll talk you through the new ETF landscape for oil and give you advisories on whether you should be long oil or short oil. We’ll give you an ETF trading strategy which you can implement on your own if you’d like. By the time you’re done reading, you should have a working understanding of how ETFs in oil could have a place in your portfolio or whether they’re not the right option for your goals.
The New Normal of Oil Pricing
Underlying the cost of most oil ETFs is the price of a barrel of crude oil. This means that you can purchase crude oil ETFs specifically, as they’re simply collections of commodities. What, then, are the other oil ETFs that are not specifically ETFs which are collected holdings of crude oil?
Other oil ETFs are dependent on the cost of oil but also incorporate stocks from firms which handle the manufacturing, refining, and servicing of that crude oil, in addition to distributing products every step of the way. The good news is that you have many different oil ETFs to choose from because there are many different stocks of many different energy companies which can make up an ETF.
Picking Out the Right Oil ETFs
While you’re browsing the ETFs, the thing you should be looking for is the expense ratio—as always—and also the fundamentals of the ETF you’re checking out. As you can see, many oil ETFs haven’t tracked the recent bull run in the S&P 500 because their fundamentals are transparently poor in comparison to clean energy.
Simply put, the market is not so interested in oil at the moment, and, in fact, it’s actively disinterested in many cases. Oil is old news compared to solar panels and clean energy ETFs which have brutally strong fundamentals whose strength grows daily.
This rules out including oil ETFs in any growth portfolio, at least for the time being. There are still several vectors for profit that are open which involve oil ETFs, as any trader will tell you. You will need to get a little bit fancy to profit from these techniques, however.
Oil and Market Volatility
In the current market conditions, you’re unlikely to turn a dime by merely shorting oil or holding onto ETFs. Luckily, oil performs very predictably under certain circumstances which you can take advantage of. Much like gold, traders flock to oil during periods of geopolitical instability or major market volatility.
By keeping a close eye on the crude oil ETF volatility index (OVX), you can find many opportunities—small or large—to go short or long as you please. You could also hold onto OVX in your portfolio if you’re interested in losing or gaining money via an unforeseen wild ride.
There’s also another way to profit via volatility, coined by Nassim Taleb’s barbell theory.
Play the Long Game
If you’re willing to accept three premises and you’re willing to make a bet, oil ETFs could be a jackpot if you are patient. We know that currently, crude oil ETFs are doing poorly, as are ETFs of refined oil products.
We also know that when there is conflict, oil ETFs become very volatile but trend upward in price. Here are the three premises which will be necessary to implement this oil ETF home run gamble:
- Premise 1: The world’s militaries still run on oil.
- Premise 2: When there is geopolitical conflict, the price of crude oil jumps upward, and with it, all of the oil associated ETFs.
- Premise 3: Buying put options far above an ETF’s day-to-day price fluctuations tend to be very cheap.
The gamble then goes something like this: pick a few crude oil ETFs or other oil ETFs and narrow them down to the ones that are the most volatile historically. Then, layout consistent daily purchases of put options for those ETFs at values that are far higher than that ETF typically reaches—30% or 40% higher to start, but getting more aggressive won’t hurt if you can afford it.
Now you play the waiting game. When will the next major war or crisis occur? Or, in today’s markets, when will the next flash-crash, or flash-boom caused by runaway HFT bots occur, spooking the old conservative money holding firms? That’s the day all those put options you’ve been wasting your money on become worth the wait.
If you plan your put options correctly, you’ll have a ladder of puts for rising prices at a sharp incline—this is how you will get filthy rich in one masterful move. Of course, you’re relying on an extreme shock to the market—which may be the only way that oil ETFs are profitable in today’s conditions.
Essentially, this trading strategy could hypothetically make an oil ETF trader a ridiculous amount of money, all in one day, provided that they’re willing to incur the acceptable minor losses of daily useless put options.
There’s no single best oil ETF or trading strategy, but there probably is an oil ETF out there which you could trade at the right time to make a profit, even if the barbell method outlined here seems too expensive or too terrifying for you to try.
The key is to watch the right news and to understand the volatility relationship that the commodity of oil has with all of the derived oil ETFs. The fundamentals of the oil stocks that compose the most common ETFs are slowly changing for the better from the abysmal, but it’ll be a long time before they’re in good shape again, and investors know it. Don’t get caught with your hand in the wrong ETF options jar, as the saying goes.