Trading oil used to be only for the elite traders trading in the oil commodities market. These futures commodity markets used contracts that covered a minimum of 1000 barrels per contract. After a barrel of oil is “cracked″, broken down into gasoline and other petroleum items that are made from a barrel of oil, 42 gallons of gas is collected. When you consider 42 gallons per barrel multiplied by 1000 barrels per contract, just think about the money you would need to be able to trade oil commodity futures. The world events of recent years have made the price of oil change at a very high rate.
Before the 1970′s oil prices stayed within a certain trading range. When the 1970′s came around all types of things changed for the oil trading market. World politics, global warming, hybrid cars, ethanol, technological advances and constant problems in the Middle East have all had their effect on trading oil. Prices have currently topped $100 per barrel and consumers getting gas at the pump feel it everyday.
The United States has generally been the largest consumer of oil and gas in the world. However, that is not the case anymore. Many countries have developed more in the past few decades and are now consuming more energy, and therefore more oil. India and China are probably the two countries that have increased their oil consumption the most. As the demand for oil increases, so does the price and the rate of change of oil prices.
The common investors never really had an opportunity or the ability to trade oil. Most traders were not familiar with the futures market, or they didn′t have the capital required to open a commodity futures trading account. The commodities futures also have a very different type of trading style. Futures trade in contracts that expire after a certain period of time. A common form of an oil futures contract would be: 1 contract of december 80 oil. That would mean you are buying a contract that will let you buy 1000 barrels of oil at 80 per barrel in December. When December rolls around you either sell the contract or let it expire worthless if oil is trading at less than $80 per barrel. It’s not like a stock from IBM that you just hold forever.
Exchange Traded Funds (ETF’s) have now been created to track almost every commodity that used to be only traded in the futures markets. The USO is the ETF that tracks the oil market. Average investors can now buy and sell the USO ETF like they would any other stock. Since the USO is traded like a stock, you can also trade options on it. Puts, calls, covered calls and all the other option trading strategies can now be used on the highly volatile price of oil.
Dennis Graves has been investing in the stock market since the early 90′s. While mostly investing in options, he also has experience in daytrading, swing trading, penny stocks and long term trading. He has also created many stock market trading sites, most recently http://www.TradeTheUSO.com which is a site devoted to trading the USO through stocks and options.
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January 28th, 2008 by admin
The growth in the number and size of margin accounts for stocks especially among day traders suggests that many people foolishly neglect these simple truths. From 1996 to 1999, margin debt rose nearly fivefold at on-line brokerage firms and doubled among NYSE member firms. During the decade of the 1990s, margin debt as a percentage of total consumer debt quadrupled from 4% to 16%. Yet many people do not understand that margin loans are not like other consumer loans.
Margin traders borrow from their brokers at rates ranging around 9 to 11% in order to buy stocks with the borrowed money. They think they can leverage those loans by using the proceeds to buy stocks whose price rises plus dividends yield greater returns. In euphoric markets those people may win, getting returns higher than the cost of the money. In gloomy markets they get crushed.
When the balance in your portfolio falls so that your margin loans are equal to about half or more of that amount, you have to put cash in to pay down that debt. If you don’t have the cash, your broker will sell some of your shares with or without your cooperation. Add the interest expense and the trading costs to a reversal of Mr. Market’s euphoria to count your losses, then multiply that by the number of overextended margin traders and you have the acute slope of a downhill market before you.
The big margin traders might as well be high-rolling in Monaco on borrowed money. Look no further than the poster boy of marginized day trading to see the stupefying riskof this strategy. The most vocal proponent of this high-stakes game is Barry Hertz, the impresario of a company called TrackData Corporation. Its marketing pitch gleefully enthused that investing was easy, and Hertz advised his customers to day trade, using borrowed funds.
Hertz at least took his own advice to double speculate. So on Q day, his own brokers called him to say they needed over $45 million to shore up his margin account. To do so, Hertz had to pledge over 50% of his shares of TrackData. Heed the advice of those like Hertz if you like what happened to him.
Financial Gambling
You would also do well to remember the tragedy of 28-year-old Nick Leeson, the so-called rogue trader working for the Singapore branch of Barings. He funded his trading with millions of dollars of borrowed money, and when the market turned against him, he brought down Barings, the oldest bankin England and the one that financed the Napoleonic wars and the Louisiana Purchase! Leeson ostensibly was doing arbitrage trading, focusing on differences in prices of Nikkei 225 futures contracts listed on the Osaka Securities Exchange (OSE) in Japan and the Singapore Monetary Exchange (SIMEX). He bought futures on one market and simultaneously sold them on the other. This was a low-risk strategy , since the two positions offset.
Its success led Leeson to another move, a straddle where hesimultaneously sold put options and call options on Nikkei 225 futures. This was a medium-risk strategy , very effective in stable markets but dangerous in volatile ones.
An earthquake that rocked Kobe, Japan, in January 1995 plunged the Nikkei and terrorized Leeson. As the market roiled, Leeson acted like a heroin addict and adopted the high-risk strategy of buying more Nikkei futures in the vain hope of propping up the fallen market. When the dust settled, Barings’s exposure on the futures contracts ran to a staggering $1 billion, far in excess of Barings’s total capital. The bankfell to its knees. Investigators discovered that Leeson’s positions had been covered by Baring’s margin accounts while he was trading, but after the crash and after Leeson fled Singapore for Germany they were not. During his trading, Leeson told Barings’s main branch in London the plausible story that he was hedging his long futures positions with private contracts and was also making hedged trades on behalf of a client of the bank. In fact, the client did not exist but was a fictitious name given to an account that Leeson invented earlier for his own use.
Leeson allegedly funded that account with proceeds from other trades and used those funds to maintain the margin account balance. He apparently used the fictitious client account to convince Barings in London to provide additional firm capital, which Lesson in turn used to shore up the margin account. In the end, none of that was enough.The Leeson lesson is admittedly an extreme psychological case tripped up in a mix of exotic securities, excess margins, and fraud. But the drama is a memorable warning that margins and exotica can get you in over your head and that mixing them can get it handed to you on a platter.
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