Investors interested in adding alternative investments to their portfolios may be considering oil futures. It checks all the boxes for an aggressive investor: Oil futures are speculative, can be highly volatile, and involve margin loans that amplify profits (and losses).
Interested in investing in oil futures? Here’s what you’ll want to know.
Read more: Oil is trading like a meme stock — here’s why it isn’t one
Investing in oil futures is buying or selling a contract on the predetermined future price of 1,000, 500, or 100 barrels of oil. The contracts are typically traded on West Texas Intermediate crude oil (CL=F), the U.S. market standard, and Brent Crude (BZ=F), an international oil benchmark.
Many investment brokerages don’t offer futures trading, but Charles Schwab, Robinhood, Coinbase, E-Trade, Interactive Brokers, NinjaTrader, TradeStation, and Webull do.
To be approved for commodities trading, brokerages typically require:
A minimum account value as required by the brokerage
An account with margin approval (approval to borrow money from the brokerage)
An appropriate investor risk profile form on file
Traders may use oil futures to hedge other petroleum-related investments, such as oil, gas, and petroleum exploration company stocks.
How oil futures trading works:
You buy a futures contract if you expect oil prices to rise.
You sell a contract if you believe oil prices will fall.
One excellent way to determine if futures trading is right for you is to use a trading simulator. Before you commit real cash to the oil futures market, you can test out your ideas in a simulated trading environment with live market data.
As you gain experience in the practice of trading futures, without risking any capital, you can build confidence in your strategies and then be ready to put money on the line.
Read more: 5 ways oil prices over $100 a barrel could hit your wallet
Futures trading often uses leverage through margin accounts. That amplifies a position while using less up-front cash. You make a good-faith deposit into your account, from which the 2% to 12% of the contract value is deducted. A minimum margin balance must be maintained, known as a “margin call.”
Charles Schwab offers an example:
“If a trader expects crude oil prices to move higher, they might buy five Micro WTI Crude Oil contracts at $65 per barrel, putting up at least $2,550 in initial margin (the good faith deposit) to establish a position in a futures contract with a notional value of $32,500.
“If oil rises to $66, the notional value of the futures position would gain $500 ($1 x 100 barrels x 5 contracts) to $33,000. If the trader sold those five contracts at $66, they’d pocket the $500 gain minus transaction costs.
“But if the price of oil falls, this same leverage would work against the trader, magnifying the loss.”
The Commodity Futures Trading Commission warns investors to approach the market with caution.
“Speculating in commodity futures and options is a volatile, complex, and risky venture that is rarely suitable for individual investors or ‘retail customers,'” the CFTC noted in an educational piece. “Many individuals lose all of their money, and can be required to pay more than they invested initially.”
Read more: What’s the Strategic Petroleum Reserve, and can it help lower gas prices?
If you’re not quite ready to jump into oil futures contracts just yet, other options are available:
Oil exchange-traded funds: ETFs such as USO (USO), BRNT (BRNT.MI) (BRNTN.MX), DBO (DBO), and OILK (OILK) track the prices of oil. Expense ratios run from 0.60% to 1.43% or more.
Energy stocks: Oil company stocks such as ConocoPhillips (COP), Occidental Petroleum (OXY), and Texas Pacific (TPL) can offer exposure to the sector.
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