U.S. oil prices have surged 14% over the last month which has become a cause for concern on the inflationary front but also for market participants looking to make a buck.
Food For Thought
It should go without saying that utilizing oil futures to profit off falling, or in this case rising oil prices, is a more pure trade for market participants. On the other hand, with an oil stock, you’re buying a lot more than just the price of oil. When one buys an oil stock, they’re buying the price of oil as well as the management team, the company’s competitive advantage, and of course the company as a whole. Market participants open themselves up to company risk when purchasing oil stocks to profit from a rise in oil prices.
Sacrificing Upside While Limiting Risk
When oil prices rise, it’s true that an oil stock may rise by more than the percentage gain in the price of oil. However, it’s also true that an oil stock may not rise by as much as the percentage gain in the price of oil, it goes both ways. For example, if U.S. oil prices rise 14%, an oil stock may rise 14% if the company is a good position to capitalize on the price rise. But at the same time, that oil stock may only rise 5% or even worse, fall 5%, if the company is not in a good position to take advantage of the rise in oil prices.
Instead, when a market participant chooses to buy oil futures to capitalize on rising U.S. oil prices, he/she gets the exact gain (if successful) in the price of oil. In this way, there is no additional company or overall stock market (index crash) risk associated with this particular trade. Therefore, it represents a more pure exposure to the underlying commodity.