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Wall Street Secrets Revealed #8 – United States Oil Fund, LP (USO) Is Designed To Go Down Over Time - Part 2

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@rollandthomas
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Futures are derivative financial contracts in which the buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date. Futures originated so that companies / farmers could hedge of their products potential losses pending volatility in price. As futures contracts have evolved, they came vehicles to speculate on price.

Because futures contracts have a limited lifespan two important attributes to pay attention is when the contract expires and contract rollover.

A contract’s expiration date is the last day you can trade that contract. This typically occurs on the third Friday of the expiration month, but varies by contract.

Offsetting or liquidating a position is the simplest and most common method of exiting a trade. When offsetting a position, a trader is able to realize all profits or losses associated with that position without taking physical or cash delivery of the asset.

Rollover is when a trader moves his position from the front month contract to a another contract further in the future. Traders will determine when they need to move to the new contract by watching volume of both the expiring contract and next month contract. A trader who is going to roll their positions may choose to switch to the next month contract when volume has reached a certain level in that contract.

When rolling forward, a trader will simultaneously offset his current position and establish a new position in the next contract month.

Source

This is why I like shorting the United States Oil Fund, LP (USO) which seeks the daily changes in percentage terms of its shares’ per share net asset value (“NAV”) to reflect the daily changes in percentage terms of the spot price of light, sweet crude oil. USO seeks to achieve its investment objective by investing primarily in futures contracts for light, sweet crude oil, other types of crude oil, diesel-heating oil, gasoline, natural gas, and other petroleum-based fuels.

What you need to know is the USO is designed to go down over time. Even though prices have collapsed with some out there saying $10 might be still in the cards for oil, oil is still in a contango. This merely means that each month’s oil futures contract is trading at higher prices...or what is called contango in the oil industry.

The way the USO endeavors to track oil is by continually holding the most relevant futures contract. And two weeks prior to the current month expiring, the fund’s managers sell the current months contract and buy about the same amount of the subsequent futures’ oil contract. And since further-dated contracts trade at higher prices, holders of the USO are selling low and buying high every single month.

The contract that expires tomorrow is trading at $11.82 now.

However, the June oil contract is trading at $22.98.

Knowing that oil was trading in contango, three weeks ago, I put on a calendar spread. A calendar spread is an options spread that simultaneously entering a long and short position on the same underlying asset at the same strike price, but with different delivery months.

Three weeks ago, I bought 10 contracts of the USO put options that expire in 2022. And since that time, I have been selling the weekly options.

But the awesome part is that as oil prices have declined, so has my put options, those options are currently up +30%

I guess the take away here is not necessary to show you that I'm profitable on the trade. The last couple of days the financial news has been talking about USO and how it has been hurting the retail investor. So the message is before placing any trades, know the instrument that you are trading, before placing the trade.

This post is my personal opinion. I’m not a financial advisor, this isn't financial advise. Do your own research before making investment decisions.


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