Oil futures ETF

Barry_Bear

From today's financial news
"The slump in prices this week will be very painful for an ETF such as USO, especially given the way that oil futures contracts mature on a monthly basis. That means that a Fund must roll over their contracts to avoid actually owning physical oil one factor behind yesterday’s crude meltdown."

Anyone here understand these contracts? What do they mean by "roll over" to avoid owning the oil? If being forced to roll over is so bad, then what happens in normal circumstances when the fund doesn't have to roll over, does it take posession of the physical oil? How is that possible? What would happen if due to an error, glitch, or misjudgement contracts were not rolled over, how is the holder forced to take delivery, or how can they get out of doing so if they have no facility to store oil?

EdGasketTheSecond

Just google it and find out; you can't expect a lesson in trading oil futures in a forum reply. It will all be revealed on a site such as investopedia.

Username999

Roll Over means that for the May contract which expires today, you sell the May contract and buy the June contract, hence "Roll Over".
If you do not roll over then you have to take delivery of 42,000 gallons of Crude (per contract).

bowlhead99

Yes, if it has contracted to receive a million barrels of oil for May delivery through a futures contract, it has to either offload the contract to someone who wants it before it matures and buy one maturing in June or later, or sell it the day it matures through a spot contract, or simply arrange for the million barrels to be delivered to its HQ and figure out how to sell them on later. And when you are an exchange traded fund, nobody wants you to use their cash on buying a load of  physical barrels of oil that you don't know when you can sell.

Barry_Bear said:

or how can they get out of doing so if they have no facility to store oil?

They can meet the rights and obligations set out in their contract by arranging for someone else to take delivery and store it. Which might be costly.

West Texas Intermediate futures for May maturity went negative yesterday while the June futures did not and other grades of crude (e.g. Brent) did not; this tells you it was related to everyone knowing there was someone with a huge amounts of May contracts that they would have trouble selling - the contracts already mature over a range of days rather than on one specific day to help defend against other people in the market front-running the expected trades that USO would need to make.

Trump would probably be happy to buy up the contracts for nothing and add to the country's national oil reserves, given many US producers may be expecting to cut production this year but oil will eventually have value again. Actually knowing Trump if it's anything like the hospital ventilator story he would arrange for the federal government to buy them up, then put his son in law in charge of distributing them to the states (the states that he liked the best), and his son in law would arrange to sell them wholesale to preferred private distributors who would then sell them on to the states - because that's the most efficient way to get them out there, using the existing wheels of capitalism - it ensures that the right people get the product and the right people make the money...

TemporaryUsernameMay2020

The short version is that an ETF like that won't simply track the oil price, i.e. if the oil price goes up 10%, the ETF goes up 10%; or if oil goes down 50%, the ETF goes down 50%; and so on. The ETF was never going to do that, because it never buys real barrels of oil (which would be impractical), it buys futures contracts instead.

Being forced to take physical possession of oil is not a risk.

An ETF might have bought May oil futures contracts. I.e. for so many dollars, they have the right to receive so many barrels of oil in May. Before that happens, the ETF will need to sell the May contracts, and buy June contracts instead. That is rolling over. (And they'll need to do the same next month, and so on.)

Now, how do the prices of the following compare?

a) a barrel of oil, for immediate delivery

b) a barrel of oil, for delivery in May

c) a barrel of oil, for delivery in June

There are technical terms to describe how those prices may compare, but to cut to the chase, any one of them could be higher or lower than any other one, depending on market conditions.

An ETF which is rolling over (i.e. selling (b) and buying (c)) will experience a profit or loss, depending on the difference between the prices of (b) and (c). And may bear no direct relation to changes in (a), the actual price of oil.

So basically, holding such an ETF is just mucking around with financial derivatives, and doesn't give you direct exposure to changes in the price of oil.

Not that there would be much point in having direct exposure to the price of oil, when none of us have any ability to predict that reliably, either.

Username999

Barry_Bear said:

 how is the holder forced to take delivery, or how can they get out of doing so if they have no facility to store oil?

Futures are traded on Margin, and rules are rules, or else you are Bankrupted.
The "CL" futures are for WTI Oil (West Texas Intermediate). All of it is stored at one site Cushing in Oklahoma by a network of pipes, mainly.
You would be forced to take physical delivery from there, or pay high fees to leave it there.

Brent Crude Futures are completely different.

Username999

The ETF USO was probably the biggest loser in all this mess, they would have been forced to Roll Over a huge loss.
You should understand what you are trading/investing in IMHO.

Barry_Bear

Great replies! I am not thinking of investing in these but wanted to know about the negative price shock affect with WTI.
Thanks for the lesson in trading oil futures!

Alistair31

Very easy to get burnt fingers with this stuff...

Username999

Alistair31 said:

Very easy to get burnt fingers with this stuff...

Well Crude Oil is very flammable!

strawb_shortcake

Futures and CFD's came up in my last exam, goodness knows why as I'll never use it in my job. I scraped through with 53% pass as it just goes way over my head