Oil Matters

Since last December, there’s been a tremendous increase of retail investors trying to speculate on the oil market.

 

Oil is a physical commodity that is traded on the commodities market with monthly delivery dates. Speculators who do not wish to take physical delivery have to rely on future contracts, and have to roll those contracts forward to future months before they expire on the third Friday of each month.

 

This roll-over activity created two interesting phenomenon:

 

(1)     The farther out month contracts are more in-demand than near month contracts. This (among other reasons) have created a phenomenon called ‘Contango’, which basically says current and near month contracts are cheaper than further out month contracts.

(2)     On the near months contracts – current and next month mostly – the contracts are in-demand for about a week after the expiration day of the previous month’s contract. After that the selling takes over until the next expiration day. Part of the reason for this is that funds like USO want to be out of the current month contract by the end of the second week.

 

If you buy USO or other instruments that rely on near term contracts, the Contango will kill you – you’ll lose 10 – 15% each month as the fund rolls over to the next month contract. Compare USO to another fund USL which uses a more Contango-tolerant strategy.

 

For short term trading, buying USO around the third Friday and selling near the end of the month seems like a good strategy.

 

Longer term, we’ll need to see a reduction in Contango before bullishness can take off.