The price of oil is down, way down. Last June’s $142/bl has been below $35/bl. Now may be a very good time to invest in oil stocks. On the other hand, prices still seems to be heading south. You have the “falling knife” risk. Yet, how low can it go? Unlike derivatives we are talking real assets here. At a certain point, pumping won’t pay. And, of course, low prices stoke demand. It is not a matter of if oil prices will rebound, it is a matter of when and to what extent. There is also the geopolitical risk and the “Peak Oil” scenario. Events in the Middle East can flare oil prices up on a moments notice.
Calling a bottom is risky. Hedging is one way to minimize risk. Thanks to easily bought and sold Exchange Traded Funds (ETFs) or Exchange Trade Notes (ETNs) you can hedge against price declines without actually shorting stocks. ETFs mostly eliminate the “corporate risk” as they often represent a “basket” of companies. ETNs are riskier as they are derivatives and are only as good as the provider.
Cash is a good place to be in today’s market. You could “hedge” against lower oil prices by holding cash in reserve. Another conservative hedge might be buying the US dollar, using the ETF UUP. The dollar and oil prices are inversely correlated to some extent. Holding UUP may be a good hedging strategy.
Using ultrashort ETFs as hedges is powerful, but risky. Things aren’t always what they seem. Often these instruments are trading tools not hedges. There have been several recent articles on the risks of ultrashort industry segment ETFs such as finance, real estate and oil.
For a more aggressive hedge you can use commodity and currency ETFs and ETNs. I compared the performance of the ultrashort oil exchange traded fund DUG, the exchange traded note DTO and the exchange traded fund SCO during 2008 using Yahoo Finance charts. See the chart here. Remember oil peaked in late June and has since declined 74% . The comparison is quite informative. You would not want to be an owner of DUG for the last three months despite its name and the rapid decline in oil prices. DTO performed very well, but carries the risk of an ETN (see above). SCO is a new ETF but seemed to have mirrored DTO’s performance over its short lifespan. Maybe SCO would be the best aggressive ETF hedge against lower oil prices.
Of course “Past results are not indicative of future performance” and I have a notoriously spotty record of timing, so you should do your own research. This article only gives you a “heads up” of where you might wish to start.
Disclosures: Long UUP
Calling a bottom is risky. Hedging is one way to minimize risk. Thanks to easily bought and sold Exchange Traded Funds (ETFs) or Exchange Trade Notes (ETNs) you can hedge against price declines without actually shorting stocks. ETFs mostly eliminate the “corporate risk” as they often represent a “basket” of companies. ETNs are riskier as they are derivatives and are only as good as the provider.
Cash is a good place to be in today’s market. You could “hedge” against lower oil prices by holding cash in reserve. Another conservative hedge might be buying the US dollar, using the ETF UUP. The dollar and oil prices are inversely correlated to some extent. Holding UUP may be a good hedging strategy.
Using ultrashort ETFs as hedges is powerful, but risky. Things aren’t always what they seem. Often these instruments are trading tools not hedges. There have been several recent articles on the risks of ultrashort industry segment ETFs such as finance, real estate and oil.
For a more aggressive hedge you can use commodity and currency ETFs and ETNs. I compared the performance of the ultrashort oil exchange traded fund DUG, the exchange traded note DTO and the exchange traded fund SCO during 2008 using Yahoo Finance charts. See the chart here. Remember oil peaked in late June and has since declined 74% . The comparison is quite informative. You would not want to be an owner of DUG for the last three months despite its name and the rapid decline in oil prices. DTO performed very well, but carries the risk of an ETN (see above). SCO is a new ETF but seemed to have mirrored DTO’s performance over its short lifespan. Maybe SCO would be the best aggressive ETF hedge against lower oil prices.
Of course “Past results are not indicative of future performance” and I have a notoriously spotty record of timing, so you should do your own research. This article only gives you a “heads up” of where you might wish to start.
Disclosures: Long UUP
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