Duration: 3:10
Level: Beginner

This lesson focuses on Oil ETPs and what investors should be aware of when deciding to invest in these products.

Contributed By: WisdomTree Europe

Study Notes:

An Introduction to Oil ETPs

For many investors, gaining exposure to crude oil prices is not always a simple task.

Physical investment needs operational know-how and expensive infrastructure and using derivatives can be complex.

A simple alternative is investing in oil exchange traded products, or oil ETPs.

Let’s look at the crude oil market and see how ETPs is fit in:

There are many different grades of crude, but two oil grade benchmarks dominate the global market:

  • Brent Crude and
  • West Texas Intermediate.

ETPs work by tracking total return indices underpinned by oil futures, typically based on the two major benchmarks.

Oil Futures Contracts

An oil futures contract is an agreement to buy a specified amount of oil on a future date at a set price.

Contracts vary in duration, with maturities ranging from one month to three years or more.

At expiry, the contract can be settled physically by delivery of the underlying oil barrels, or financially based on the value of the contracts at expiry.

Prices

For any given maturity, futures prices are a function of:

  • The spot price,
  • Prevailing interest rates, and
  • Oil storage costs.

An ETP’s price reflects what’s known as a total return exposure to the underlying oil futures investments after fees and costs are deducted.

Total Return Components

The total return has three components:

  • The price return reflects price movements in the underlying futures contracts.
  • The roll yield is the loss or gain caused by reinvesting or rolling a futures contract that’s nearing expiry to a longer dated one.

Rolling is necessary for an oil ETP to maintain constant exposure to oil prices, and

It’s important to recognize the roll yield can be negative or positive.

For an investor who is long, the oil price rolling into a longer dated futures contract that’s priced higher, known as contango, the investor incurs a loss.

And if the new contract is price lower, known as backwardation, the investor enjoys a gain.

  • Collateral yield, which comprises the final component of total return, is the interest earned on the cash value of the investment.

That is why the returns from an ETP can be different from those quoted by mainstream sources.

Other Factors

An additional factor is currency exposure.

Because crude oil is priced in US dollars, so too are oil ETPs.

That means non-dollar investors inevitably take on a currency risk.

To mitigate this, investors can buy currency-hedged oil ETPs.

Oil ETPs can be traded directly through online trading platforms and brokers or through financial advisors.

They provide a simple, cost effective way to acquire a total return investment in oil futures whilst avoiding the complexity of futures trading.

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Disclosure: WisdomTree Europe

This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.

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Disclosure: Complex or Leveraged Exchange-Traded Products

Complex or Leveraged Exchange-Traded Products are complicated instruments that should only be used by sophisticated investors who fully understand the terms, investment strategy, and risks associated with the products.  Learn more about the risks here: https://gdcdyn.interactivebrokers.com/Universal/servlet/Registration_v2.formSampleView?formdb=4155

Disclosure: Forex

There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.