We get it…you want exposure to oil and think Barclays’ NYSEARCA:OIL is the best way to do it. We aren’t surprised about this at all.
I mean…oil is being talked about a lot lately and has been in play for well over a year now. OPEC has meetings multiple times a year where they talk about potentially cutting production supply in order to increase the price of crude oil.
Regardless of the outcome, whenever there is an OPEC meeting, crude oil is in play as it brings a lot of volatility. And when there is a lot of volatility we can be sure that there will be two-sided market action for us, thus, liquidity and opportunity.
NYSEARCA:OIL is an option for getting exposure to crude oil. Let’s see if it is the best solution for not for you.
Barclays Bank PLC S&P GSCI Crude OIL TR ENT
That is a mouthful. Just like with other managed funds with crazy long names, it makes us think of a marketing ploy instead of a great vehicle to make money with.
In order to find out if NYSEARCA:OIL is an excellent way to get exposure to oil, we need to figure out if it is:
- correlated to the price of crude oil
- liquid enough for us
If these two things check out, we can go ahead and say $OIL is an excellent way to get exposure to the crude oil market.
First up…correlation to crude oil.
Correlation to Crude Oil
The way we will factor this is we take the price movement of crude oil every trading day for the last year and compare that price movement to that of $OIL. If crude oil and $OIL were both up 1% on a given day, we would call that 100 correlation. If crude oil were up 1% and $OIL were to be down 1%, we would call that correlation -100. And finally, if crude oil were to be up 1% and $OIL were to be up 0%, we would call that 0 correlation.
If we are going to say that NYSEARCA:OIL gives us a similar price movement to crude oil, we would expect to see a correlation of over 70.
What do we have?
Barclays Bank PLC S&P GSCI Crude OIL TR ENT has a 78 correlation to the price of crude oil. While not 100% correlated (moving tick for tick), $OIL is highly correlated to the price of crude oil and gives us the proper type of price movement for what we are looking for here.
Does $OIL Have Enough Liquidity?
Price correlation checked out. Now we have to find out if NYSEARCA:OIL has the proper liquidity.
Remember, liquidity is the level of participation in an asset. The more liquidity the asset has, the more competition there is in that asset and thus, the better prices we will be able to trade and invest at. This is a non-negotiable trait. All assets must be liquid enough for us to trade and invest our money in.
We look for two things: stock liquidity and options liquidity.
We will look for two things when it comes to stock liquidity:
- Bid/ask spread of the stock must be smaller than a few pennies
- Volume of the stock must be in the millions
If these two components happen, we know there are going to be fair and deep markets in the stock. Let’s see how NYSEARCA:OIL does.
For starters, we see a $0.01 wide bid/ask spread. It does not get better than this. We do not have to enter a stock position at anything worse than fair value. Awesome.
But what about the stock volume? We hope to see in the millions here…
Almost three million. Checks out.
$OIL has a liquid stock market.
On to options liquidity…but first…why do we care about options liquidity?
Because we HAVE to be able to trade options in and around our stock positions to lower our risk and give us better odds of making money. If you cannot improve your stock position, what are you doing trading or investing in the stock in the first place?
Here are the factors we look for to know if the options markets of a certain asset are liquid or not. If these do not pass our test, we have to walk away.
- Volume in the thousands
- Monthly and weekly expiration cycles
- Bid/ask spreads less than a few pennies wide
- Open interest in the thousands
Let’s jump right in. Surely if the stock traded almost three million shares we should easily see a few thousand contracts traded. What do we see for NYSEARCA:OIL?
2,508 is pretty underwhelming, however, it does not completely disqualify NYSEARCA:OIL from having a liquid options market. We just need to do some more investigation now.
Next factor…expiration cycles. Stocks get monthly expiration cycles out of the box, however, if there is enough demand for then, those same stocks also get weekly expiration cycles. What does $OIL have?
We only see monthly options expirations for NYSEARCA:OIL. This is also very underwhelming as there is not enough demand for the market makers to create and provide weekly options here. $OIL is not looking very good at this point.
The next factor is the bid/ask spread of some of these options contracts. We need to see them pennies wide.
When we see a stock that is about $5 and it’s options only trade in nickel increments, that is a bad sign. If these options markets would be liquid, we would see $OIL’s options trade in pennies and not nickels.
Lastly, we expect to see open interest in the thousand. Again, this is for a liquid product, which clearly, $OIL is not.
While the $6 calls do have an open interest in the thousands, all of the other strikes do not.
We can go ahead and say what everyone is thinking. NYSEARCA:OIL does not have a liquid options market, thus we cannot recommend it as a logical way to get exposure to the price of oil.
nysearca:oil Is Off The List…How Do We Get Exposure to Oil?
Unfortunately, we do not recommend the United States Oil Fund ETF $USO either (although it is crazy popular) as a way to get exposure to the crude oil market because $USO’s price has a negative drag 80% of the time.
At the same time, crude oil futures are a product that we consider too large for a majority of investors out there. Currently, the notional value of one crude oil futures contract is $48,410 and the one day expected PnL is about $720. That is a lot for one contract considering the margin requirements for one contract are $3,190. This means the expected profit or loss for one day with one crude oil futures contract is more than 20% of your initial margin requirement. This is too much.
We just ruled out NYSEARCA:OIL being a replacement for getting exposure to the price of crude oil because it’s options liquidity was not there.
We also ruled out crude oil futures because they are too big.
So we need to find a product that is highly correlated to crude oil and also is liquid enough (and not a giant product).
SPDR S&P Oil & Gas Exploration & Production ETF $XOP
We aren’t going to trade NYSEARCA:OIL. We are going to trade $XOP.
What is XOP’s correlation to crude oil?
Very high. In fact, higher than NYSEARCA:OIL’s 78 correlation.
But what about liquidity? How many shares traded today?
HELLO. How about options volume?
HELLO. These are big boy numbers. In fact, $XOP is one of the most liquid stocks in the world.
At the same time, NYSEARCA:OIL is too small and crude oil futures are too big, how much does it cost to buy 100 shares of $XOP?
We have a winner! Want exposure to crude oil? Ditch NYSEARCA:OIL. Ditch crude oil futures. Get involved in $XOP.