What is the Oil ETF?
Oil ETF, as the name suggests, is the exchange-traded funds which invests in the firms operating across commodities in the oil and gas industry, tracking a particular segment of the market and coming up with a unique proposition that allows investors to take positions without worrying much about the threshold or margin requirements and trade very much like they do inequities.
Examples of Oil ETF
Following are some examples of top traded oil ETF in international markets:
#1 – XLE
- Full Name – Energy select sector SPDR
- Assets Under Management – $ 13 Billion
- Expense Ratio – 0.14%
- Performance – 21.47% (1-year return as per 2015 stats)
#2 – CRAK
- Full Name – Vleck vectors Oil refiners ETF
- Assets Under Management – $ 24.82 million
- Expense Ratio – 0.59%
- Performance – 36.57% (1-year return as per 2018)
#3 – USO
- Full Name – United states Oil fund
- Assets Under Management – $ 3.95 billion
- Expense Ratio – 0.72%
- Performance – 45.97% (1-year return as per 2018)
Types of OIL ETF
Oil ETF is not very different from mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. with the only difference that they can trade at an exchange in real-time much like shares. Mutual funds, on the other hand, are valued based on the final settlement price at the end of the day. Also, there is no minimum threshold, and even retail investors can sell an oil ETFETFAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange. with small amounts. There are four main types of Oil ETF:
#1 – Leveraged Oil ETF
Leveraged Oil ETF focusses on the amplified returns compared to the benchmark index while maintaining the minimum losses. For example, a double ETF focusses on getting the double returns to the movement in the benchmark index.
#2 – Inverse Oil ETF
Inverse Oil ETF focuses on getting returns if the oil prices move in the opposite direction. For example, if the oil prices dropped by 7%, such would be the composition of the index that the returns would be approx. 7%. Because of this, most often than not, the inverse oil ETF is the best hedging mechanism among the available Oil ETF options.
#3 – Smart Beta Oil ETF
Smart Beta Oil ETF does not have a specified strategy, but these funds focus on maximizing returns based on smart, unconventional strategies and tactics. They are very risky but equally rewarding.
#4 – Index ETF
Last but not least is the index ETFs. These are the vanilla products that try to mirror the basket of different varying products.
Advantages of OIL ETF
Some of the advantages are as follows:
- Investors always an eye for crude oil and its derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. contracts. In fact, such is the penchant for this commodity that even the five year and 10-year contracts are liquid and highly volatile. Unlike bitcoin or cryptocurrencies, it is not one of those assets which have been conceptualized only on paper where valuations are defined based on the euphoria created by the speculators with fundamentals being left behind.
- Oil, on the other hand, is one of the richest industries of the last century. In fact, it is the backbone of other major capital-intensive industries IndustriesCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining. like airlines, auto major, and to some extent, fast-moving consumer goods. As per independent research in 2018, the oil industry size was estimated at 2.5 trillion $.
- In fact, the expenditure on this industry by consumers is much more than other commodities like iron, gold, silver, etc. however, because of the huge volatility involved, many retail investors are not able to participate in this industry and are forced to be away from this unpredictable but fundamentally sound commodity marketCommodity MarketThe commodity market is a place where people buy and sell positions in commodities such as oil, gold, copper, silver, barley, wheat, and so on. Started with agricultural commodities, there are now fifty main commodity markets throughout the world, dealing with over a hundred commodities.. It helps those investors in investing as a basket without worrying about the multiple industries which might be located very far geographically and thus eliminating country riskCountry RiskCountry risk denotes the probability of a foreign government (country) defaulting on its financial obligations as a result of economic slowdown or political unrest. Even a little rumour or revelation can make a state less attractive to investors who want to park their hard-earned income in a reliable place..
- Dealing in Oil ETF provides the best hedge for the retail investorsThe Best Hedge For The Retail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. as well as for the firms that already have oil positions. Consider the example of the aviation industry that unknowingly has huge exposure to oil contracts because of the very industry they worked on fuels on this energy source. It helps these firms in hedging their naked positions and making sure the profitability in intact.
Important points are as follows:
- Oil ETF invests in companies across oil and gas commodities through commodity pools with limited partnershipsLimited PartnershipsIn a limited partnership, two or more individuals form an entity to undertake business activities and share profits. At least one person acts as a general partner against one limited partner who will have limited liability enjoying the benefits of less stringent tax laws. through both derivative contracts such as futures and options and shares of the firms dealing in these commodities.
- Oil ETF works as a proxy for investors who want to participate in oil traded firms and reap potential benefits. These investors can only focus on the oil index without worrying about operational issues like logistics, delivery, storage, etc.
- The volatile industry of oil is quite popular among investors because of the returns that it offers. It offers huge returns, but with huge returns, the huge risk is involved. The prices of oil contracts move up and down in a very short span of time. This is because the underlying commodity – oil, is highly volatile and is affected to a huge extent by the global political conditions. If the global economic growth and political conditions are stable, oil prices would be stable.
- However, if there is a global turmoil or a war-like situation or a political crisis, oil prices are impacted hugely, and conversely, the oil contracts rise or fall multi-folds. Also, oil prices are impacted even when there are talks about recession as the receding economy requires less oil, which is again a concern for the investors and affects the oil prices, thereby oil contracts. To cut the story short, trading in oil requires a good amount of volatility, which everyone cannot digest. However, trading in Oil ETF helps investors in taking positions without worrying much about volatility,
Given its sheer size and economic importance in the global economic and political scenario, the oil industry is the darling of the investors and traders. Consequently, the corresponding contracts are equally popular but riskier because of the very nature of the derivative marketsDerivative MarketsThe derivatives market is that financial market which facilitates hedgers, margin traders, arbitrageurs and speculators in trading the futures and options that track the performance of their underlying assets.. However, using oil ETF, one can understand and take positions in the oil commodity and reap profits.
This has been a guide to Oil ETF and its definition. Here we discuss four main types of Oil ETF along with examples, advantages, and disadvantages. You can learn more about investment from the following articles –