Oil Ready for Rebound?

Since the start of May, oil has now fallen about 20 per cent. It closed today below $70 for the first time in 2010. Off the record, I urged my friends not to buy oil stocks or oil ETFs if they plan to day trade it, unfortunately, many continued to buy. I am not a fan of going against the grain, against such negative momentum until a clear buy signal hits the market. There is so much uncertainty in the market right now and we could definitely see oil continue to fall another 10 per cent, but the time to buy is getting close. A 20 per cent correction is a substantial drop, especially in less than three weeks, but the fundamentals on oil are starting to headline.

Analysts on CNBC discussed today that oil is becoming extremely cheap and it has been greatly over sold. Their reasons are simple: No new supply in oil reserves and an over reaction in the commodity market. So how can regular investors like us profit on the next move up, if they are correct?

Much like gold, oil and many energy commodities also have ETFs. In the US, the most commonly-traded oil ETF is the United States Oil Fund [USO:AMEX]. It tracks the current front-month futures on oil and goes up and down with a 1:1 ratio.

In Canada, many traders like the Horizons BetaPro NYMEX Crude Oil Bull+ Fund [HOU:TSX] because it provides double exposure to the move of oil. That is, if oil moves up 1 per cent, the fund moves up 2 per cent.

These two products are good for position trading, but are not good for long-term strategies. One main reason is something called "Contango." This term describes the price difference between the spot rate and a future delivery contract. Simply put, the cost of an oil contract expiring in May should cost less than a contract expiring in July. This compensates for time, interest rates, storage fees, etc. As a result of Contango, when the oil contracts are rolled over, the ETF loses on this spread. For example, if May oil is $70 and June is $73, on the day of rollover, the fund's value stays the same, even though the real price of oil is a little higher.

So, if you're looking to play oil but don't want to own a stock like BP, then you could consider energy ETFs described above. As always, ensure these products are suitable for your investment needs and contain the risk of losing a portion of your original investment.