Is Trading USO (United States Oil ETF) A Good Proxy for Trading Crude Oil? 25 Million Shares Says So

Many small investors have taken to trading ETFs (Exchange Traded Funds) to participate in the movement of a specific category of investment. Gold, Silver, Stocks and Crude Oil are some of the more popularly traded vehicles. In the long run, the correlation between the ETF and the instrument it is tracking, can be very high, however, in some cases the discrepancies in investments are surprising.
In addition to the rates of return of the investment, the costs of trading ETFs can be significantly higher than those of Futures Contracts. If one is Trading Options Contracts, the difference in costs between trading USO and Crude Oil Options is immense. For one to be successful in trading, eliminating unnecessary expenses, through liquidity analysis, is essential. The first Chart below exemplifies the differential of rates of return between the USO and Crude Oil since the beginning of the year. It provides a daily comparison of the difference between going long Crude Oil and USO. The difference between returns of the two products is pretty surprising.

If one purchased USO on January 4th on the close, they would have paid $10.98 a share. The price of Crude Oil on that date was $36.88. As one can see, using Monday’s numbers, the price of USO was $10.59 while the Crude Oil price was $41.62. The rate of return on the investments were -3.68% for USO versus 11.39% for May Crude Oil. The Chart shows returns on investment in the two instruments depending on when one entered the trade. The reality is that for this time period, being long USO did not come close to matching the returns of being long May Crude Oil. When trading any ETF (Exchange Traded Fund), one must consider whether the components of the fund can replicate the results they are trying to achieve. If one is trading USO as a proxy for Crude Oil, they are unlikely to accomplish that goal. For those that are trading SPY (SPDR S&P 500 Trust) as a proxy for the S&P 500 Index, they are very likely to accomplish their goal.

Another factor to consider when trading ETFs is the cost of trading the product. The second Chart below shows the costs per thousand dollars to participate in not only the underlying USO versus Crude Oil, but the cost of trading their options contracts. The cost differential is significant. Although USO maintains a 1 tic wide market in both their ETF and ETF Options (as exemplified below) when one factors in the size of the contract, it becomes an expensive way to trade “oil”. As shown in the Chart below it costs 95 cents per thousand dollars traded based on the bid/ask spread in USO versus 24 cents per thousand dollars traded using the bid/ask spread in Crude Oil. In the options contract it is $23.81 per thousand in USO versus $ 13.33 for Crude Oil. It couldn’t be clearer, liquidity counts.

Evaluating liquidity, Implied and Historical Volatility, the Skew and numerous Options Trading Strategies helps every Options Trader improve their likelihood of success. In this particular case, it is crystal clear that trading USO can be a costly proposition. Through leverage and liquidity, Options Trading provides speculators a methodology for leveraging their ideas and increasing returns.Contact us  to enhance your trading skills with our Private Webinar Training Sessions.  

OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.

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