How to Trade & Invest in Oil

Steps to Start Trading Oil

1. Understand what oil trading and investing is
2. Open a tastytrade trading account
3. Select How to Trade or Invest in Oil
4. Open your first position
5. Monitor, manage, and close your trade

1. Understand What Oil Trading and Investing Is

Regardless of what product you are using to gain exposure to the oil markets, trading oil is the act of buying or selling an asset to gain a profit. Oil trading from a short-term perspective could be tied to economic reports related to oil, like the OPEC Monthly Oil Market Report, or the EIA Weekly Petroleum Status Report to name a few. Oil traders may be inclined to use futures or options to gain market exposure, as those offer short-term leverage.

Oil investors may be seeking a longer-term exposure to the oil markets. Investors could look to invest in oil-related stocks involved in exploration & production, oilfield services, or even oil ETFs & ETNs. It is important to note that when investing for the long term, certain ETFs & ETNs are subject to contango and backwardation in oil futures markets, and that can impact the performance of the ETF or ETN. For example, when oil futures are in contango, oil ETFs that buy oil futures and rebalance regularly could be subject to ETF drag, where the ETF underperforms over time. When oil futures are in backwardation, this could cause the ETF to drift higher. For these reasons, be sure to understand exactly what you are trading before diving into the oil markets.

What Are the Different Oil Markets?

When you start to search for oil products to trade, you will notice that there are many different options. While you can get as granular as you would like for specific market exposures, oil markets typically ebb and flow based on the two main benchmarks that most oil traders & investors keep an eye on.

The two main benchmarks are:

• West Texas Intermediary (WTI): This is the main benchmark for oil prices, and it is produced in North America. WTI crude is considered lighter and sweeter than Brent Crude and is ideal for gasoline production. These crude oil futures (/CL) and micro-crude oil futures (/MCL) are traded on the New York Mercantile Exchange (NYMEX) division of the Chicago Mercantile Exchange (CME). They offer an abundance of liquidity in both the futures and options on futures markets.
• Brent Crude: This oil blend was first extracted from Brent oil fields in the North Sea. Brent crude is the leading benchmark for oil prices overseas, and accounts for roughly two-thirds of oil production. Brent is typically used in gasoline, jet fuel, and diesel fuel production.

What Drives the Price of Oil?

What affects the price of oil can be based on several factors, but the main two drivers are supply and demand. If there is a disruption in an oil pipeline, you could see a sharp reaction in oil futures. If there is a surprise in an EIA or OPEC report, you could see a reaction in oil futures prices. These direct reactions can trickle down into other oil products, like an exploration & production stock for example.

Oil can also be affected by geopolitical factors such as war, and natural disasters that may affect oil supply chains. Even changes in interest rates or the strength/weakness of the US Dollar can affect how oil futures and oil ETFs can be priced.

When developing a trading plan for oil products, it is important to realize that there is a myriad of factors that can affect the price of oil. This adds to the implied volatility of the product and emphasizes the importance of adjusting risk to account for these unknown factors.

2. Open a tastytrade Trading Account

With a tastytrade account, you can trade stocks, options, futures, and crypto all in one place. You can trade oil markets in a variety of ways, with different account types.

3. Select How to Trade or Invest in Oil

There are multiple ways to get exposure to oil prices, depending on your risk tolerance and preference for trading products. Here are a few possibilities available to trade on the tastytrade platform:

Oil Futures

The main oil futures contract is the Light Sweet Crude Oil Futures contract that offers the exposure to 1,000 barrels of oil. The ticker symbol is /CL, and the month and date codes associated with futures contracts tell you when the contract is set to expire. This contract is priced per $1,000, meaning a one point move in /CL represents $1,000 in profit or loss. If crude oil futures are trading at $65, that is $65,000 in notional risk. The smallest tick size is $0.01 for /CL which equates to $10.

Available oil futures contracts:

• /CL – Oil
• /MCL – Micro Oil

The micro–Crude Oil futures contract is ten times smaller than the main contract. This means that each point is worth $100, and if /MCL is trading for $65, that is $6,500 in notional risk. The smallest tick size is also $0.01 for /MCL, but that equates to $1.

Learn more about futures contracts and how they work

Oil ETFs

There are a handful of oil ETFs available to trade, but it is important to understand how the oil ETF is constructed before diving in. For example, the United States Oil Fund (USO) does not represent a basket of oil stocks. Instead, it gains exposure to oil futures, and the portfolio is rebalanced regularly to account for expiring futures contracts. For this reason, USO is subject to contango and backwardation in the oil futures market, and USO’s price can change based on how steep the contango or backwardation is in the oil futures market.

Be sure to check the prospectus for oil ETFs you are interested in trading to ensure you fully understand how the product is constructed.

Oil Stocks

• Oil exploration & production companies: These companies seek out and extract oil & natural gas from the earth.
• Oilfield services companies: These oil companies provide tech, equipment, and services to facilitate oilfield production.
• Oil refining companies: These oil companies take the extracted oil product and refine them into products like gasoline, diesel fuel, and jet fuel.
• Integrated oil companies: These oil companies can be integrated into many steps of the process, but these are your bigger “household” names where you fill up at the pump—companies like Chevron (CVX), BP (BP), and ExxonMobil (XOM) fall into this category.

Oil Options on Futures

Options on futures can be utilized to speculate on, or hedge against, movement in the oil futures market. Oil futures options settle to the oil contract itself, and that futures contract expires a few days later. Oil futures offer a lot of leverage which can amplify gains & losses, and options on oil futures are even more leveraged trading instruments.

The /CL futures contract settles to 1,000 barrels of physical oil, although an exceedingly rare situation to arrive at as a retail trader. The /MCL micro futures settle to cash, so if an options position is held until it converts to the /MCL contract, the /MCL contract will be cash-settled at expiration.

Learn more about the nuances of options on futures

4. Open Your First Oil Position

Once you have your brokerage account opened and ready to trade, you can dive into the oil market through products like oil stocks, oil ETFs, oil futures, and even oil futures options.

5. Monitor and Manage Your Trades

Monitor and manage your oil positions using the positions tab on the tastytrade platform. You can close or roll positions directly from the positions tab and view a variety of position metrics.

You can also consider using the bracket order system to enter profit target and stop loss conditional orders to let the platform work for you while you are away.

Learn more about bracket orders and how they can be used for position management

Oil Trading Examples

In the examples below, we will explore trading oil products on the tastytrade platform. Whether you are trading oil futures, or options on oil futures, the tastytrade platform simplifies trade navigation.

Learn more about the tastytrade desktop, mobile, and web platforms

Oil Futures Trading Example 

1. Enter your preferred oil futures trading symbol in the ticker symbol box or locate it along the left side of the platform in the watchlists – for this example, we will use the Micro WTI Crude Oil Futures contract (/MCL). The active month will automatically populate, but if you want to trade a different contract type in the full month code and year.
2. To buy the contract, click on the ask (buy) button to load the long contract on the trade page. To short the contract, you would click the bid (sell).
3. Once the oil futures trade is loaded on the trade page, you can change the quantity of contracts, price, and order type if you would like. When you are ready to send the order, click the review & send button to review all aspects of the trade, including commissions & fees. If everything looks good, click send order on the following screen to route the order to the market to be filled.

Oil ETF/Stock Trading Example

1. Enter your preferred oil ETF trading symbol in the ticker symbol box or locate it along the left side of the platform in the watchlists – for this example, we will use the Oil & Gas Exploration & Production ETF (XOP).
2. To buy the ETF, click on the ask (buy) button to load 100 shares on the trade page. To short the ETF, you would click the bid (sell). 
3. Once the ETF trade is loaded on the trade page, you can change the number of shares, price, and order type if you would like. When you are ready to send the order, click the review & send button to review all aspects of the trade, including commissions & fees. If everything looks good, click send order on the following screen to route the order to the market to be filled.