thinking about investing in crude oil, anyone know much about investing in this commodity?

Question

Seems like the perfect commodity to invest in from an economic standpoint, limited resources/ huge demand...what are the drawbacks?

Answer 1

Commodities (such as oil) are highly volatile, and generally risky investments. If you are absolutely convinced that oil is going to go up and are willing to risk your shirt, go buy oil futures. This is the option/right to buy oil at a certain date at a certain price, usually close to today's price. If, on that date, oil is worth more, you simply buy for today's low price and sell for the high price.

However, you can lose everything this way. Price is lower on that date, and you have to buy the oil at the higher price, and sell low. You could lose a LOT of money.

A more risk averse method would be to invest in commodity base d Exchange Traded Funds, such as DBC or GSG, which invest heavily in energy/oil futures, but hedge their bets with T-bills so they aren't as risky. They are about as risky as stocks - you can't lose more than you put in, and are unlikely to lose all or nearly all of your investment. But, then again, you won't quadruple your money in a week either.

Answer 2

Adam L. is on the right track, but is getting futures and futures options on crude mixed up. If your trading options, you have the right to buy the underlying at a specificed price within a specified time frame. If the options is out of the money at the time it expires, then it worthless and you lose your premium paid. If it is in the money, then it's cash settled at expiration, or if it's in the money, you can exercise the option and take delivery or make delivery of the futures contract to the options writer the exercise has been assigned to. This only applies if you are buying a call/put option. If you're writing a call/put, that's a different issue.

If you have a futures contract, at expiration, you are obligated to make/take delivery of the physical commodity. Most people close out or roll over their futures prior to the expiration of the futures contract.

Now, I do agree with Adam that you should invest in energy ETF's. Energy derivatives are very risky. What Adam and the Shark failed to consider is that you can short the energy contracts if you feel oil is going to fall. As a matter of fact, if you had shorted 1 futures contract at $75 and covered at $54, you have made $21,000 ($21 price differential x 1000 bbl of crude - 1 crude contract is 1000 bbls). But futures have the potential for unlimited gains AND unlimited losses. It is not for the timid or faint of heart. Unless you have deep pockets and a high risk tolerance level, I would suggest that you take Adams advice and stick to energy ETF's or energy sector equities.

Answer 3

The drawbacks are your info isn't necessarily correct.

Oil was recently $75, now it is under $55 and on the way down, There are as many reasons to go down as up.

Commodities are risky...Stay out if you don't know what you are doing