Why Trade an ETF?
ETFs like USO trade like shares of stock. That structure carries less risk than trading futures contracts directly. And you don’t need a futures account to trade an ETF like USO. You can even trade USO in retirement accounts like IRAs.
Contango and Backwardation
We can visualize the futures term structure or the forward curve by plotting the prices of a series of futures contracts over time.
When longer-dated contracts are trading at a higher price than the front-month contract, that forward curve is in “contango.” Alternately, when longer-dated contracts are trading at a lower price than the front-month contract, the forward curve is in “backwardation.”
The front-month price and the longer-dated price will meet in the middle somewhere as time goes by. But that does not necessarily mean that oil prices will go down. Over time, the oil price can go up or down, and the forward curve will adjust.
Physical products like oil are often in contango because of the costs associated with storage and transportation. These costs are assumed to make oil for future delivery more expensive. But when near-term supply is constrained, the front-month contracts for sooner delivery can be more expensive, and the forward curve will be in backwardation.
Roll Yield
An ETF like USO is maintained by rolling contracts forward over a 10-day period. The closer in contracts are sold, and farther dated contacts are purchased to replace them.
The gain or loss from completing those rolls creates a roll yield that can be either positive or negative.
Positive roll yield exists when a futures market is in backwardation when short-term contracts trade at a higher price than longer-dated contracts. When the market is in contango, the longer-term contracts are more expensive than short-term contracts, and roll yield will be negative.
Currently, the oil futures curve is in backwardation. The contract for one year away is trading nearly $25 lower than the front-month contract. That implies that supply is tighter now than expected in the future.
Backwardation can provide a bit of a tail-wind to an ETF like USO when the fund managers are selling relatively expensive short-dated contracts and replacing them with lower-price contracts dated further out.
Conclusion
After many years of buying and selling options using a wide variety of strategies ranging from the simple to complex, I find that a simple strategy like selling puts can be one of the easiest to manage and most reliable for generating regular profits. Don’t make it more complicated than it needs to be!
Do You Want To Learn More About Options Trading?
Every day on Options Trading Signals, we do defined risk trades that protect us from black swan events 24/7. Many may think that is what stop losses are for. Well, remember the markets are only open about 1/3 of the hours in a day. Therefore, a stop loss only protects you for 1/3 of each day. Stocks can gap up or down. With options, you are always protected because we do defined risk in a spread. We cover with multiple legs, which are always on once you own.
If you are new to trading or have been trading stock but are interested in options, you can find more information at The Technical Traders – Options Trading Signals Service. The head Options Trading Specialist Brian Benson, who has been trading options for almost 20 years, sends out real live trade alerts on actual trades, such as TSLA and NVDA, with real money. Ready to subscribe, click here: TheTechnicalTraders.com.
Enjoy your day!
Chris Vermeulen
Founder & Chief Market Strategist
TheTechnicalTraders.com
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