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ETF Talk: Rising Oil Prices Offer Investment Gift

December 22, 2010
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Motorists driving to visit family and friends this holiday season may not like rising oil prices, but the trend does provide investors with another way to profit.

Oil is among the commodities that have been boosted by encouraging reports about a budding economic recovery. One exchange-traded fund (ETF) that’s benefitting from this trend is the United States Oil Fund (USO).

The fund is designed to track oil prices, but essentially it reflects the changes, in percentage terms, of the spot price of light, sweet crude oil. As you may know, crude oil is one of the most important physical commodities, as it literally fuels global economic activity. Well, WTI light, sweet crude oil futures contracts are the measure by which traders assess the supply, demand and price of this vital commodity. The WTI light, sweet crude oil futures contracts also are regarded as the primary U.S. benchmark for crude oil prices.

There is a unique risk with USO that I want to bring to your attention. The risk is called a “roll penalty” and it occurs when an ETF sells out of expiring futures contracts and pays a premium for the following month’s contracts. In well-supplied markets, each month’s contract is a little more expensive than the previous month’s contract. The difference helps to cover the cost of storing a commodity. That disadvantage should not necessarily deter you from investing in an ETF such as USO, which still could help you to profit from a jump in oil prices. Click here to read a Nov. 30 article from The Wall Street Journal that addresses this particular risk.

However, USO also offers strong benefits. It provides an investment vehicle to hedge crude oil movements or to take directional positions on oil prices. It also gives you commodity-like exposure without having to open a commodity futures account.

If you are afraid of climbing aboard a bandwagon that already has left the station, allay your concerns. The chart above of USO shows that the fund has not taken off to stratospheric levels. You therefore still can buy USO at a reasonable price.

For advice about which ETFs to buy and to sell, I urge you to sign up for my ETF Trader advisory service. As always, I am pleased to answer any of your questions about ETFs, so do not hesitate to contact me if you have one. To send a question to me, simply click here. You may just see your question answered in a future ETF Talk.