Investment Basics - Making Money Using Oil Prices
Thursday April 23, 2009
Oil prices affect almost everyone's daily life in one way or another. As markets fluctuate, many people consider investing in one of the world's most desired products. However, how do people invest in oil, and what ways can you go about it?
The well-worn image of the rich Texas oil baron in a white suit firing off a six-shooter may scare away the new investor, but rest assured, you don't need to be a millionaire or own a six shooter to take advantage of oil prices. There are numerous ways for all levels of investors to take advantage of world oil prices.
However, like any investment, you should consult professional advice before delving into a financial commitment. The price of oil is one of the most speculative on the market and everything from civil unrest to extreme weather can affect its value.
As many people are finding out, the global economy also plays an important part in the oil industry, and overall, it is supply and demand that will have the most effect on long-term oil prices. On top of all that, there's the future potential of alternative power sources coupled with the knowledge that oil reserves around the world are finite.
However, in the short term, oil is here to stay and it's safe to say many people will make money on oil prices for some time to come. When deciding exactly how to invest in the price of oil, the first thing to look at are your goals for profit, how much risk you are willing to take on board and the amount of capital you can devote to your investment. Here are some common ways to invest in oil prices:
Stocks
For the average investor, buying a large oil company's shares on the stock market could be a relatively secure and rewarding option. The bigger businesses hold the most likelihood for a secure return in the future, especially as economic conditions change.
Two popular Australian companies that have large oil supply operations are BHP and Woodside Petroleum, and the share prices in these companies will usually move at a much smoother rate than the underlying asset. This reduces risk, and will suit many retail investors.
Targeted Investing
For someone willing to take a risk on a certain amount of their capital, investing in a smaller oil company may reap handsome rewards. This can be done in many ways, and elements such as drill sites, political affairs and seismic activity should all be taken into account.
For a new investor, this type of investing is not often recommended. While the rewards have in the past netted investors huge amount (upwards of 700%), the chance of large losses is also a dangerous possibility.
Oil Futures and Options
The derivatives market, such as oil futures and options, is another popular way to invest in oil, but it may take beginners some time to understand exactly how it works. One of the main advantages to this type of invesmtent is leverage, which means you can access large rewards for a minimum initial outlay. However, be aware that leverage can work both ways.
You will need a certified futures and options broker, and it is highly recommended to recieve proffessional advice for these investment types. Depending on the contract, futures and options give an investor the ability to buy or sell a particular commodity on or before a specified future date.
In this way, investors can also trade declining markets if they believe prices will fall, and in the case of options contracts, you are not obligated to fulfill the contract if prices move against your predictions. Of course, you will lose the original value of the contract, but when trading futures, the worst-case scenario could be much worse.
While the degree of risk here is high, with the advantage of leverage and careful research, oil futures and options can be a lucrative and rewarding investment.
Oil ETFs
ETF stands for exchange-traded funds. They are similar to mutual funds, where a combination of assets is held in the fund, except in the sense that they trade throughout the day like regular stocks. Usually, the ETF will follow the prices of the underlying asset, which in this case would be oil prices.
ETFs have been praised as a simple and more secure way for individuals to invest in commodities, but some critics have been disappointed with the returns of some ETFs.
This list is not exhaustive, but it does show you some common ways that the current oil price can make you money. Oil prices can be among the most volatile in the market, but for such an important commodity, there are definitely rewards to balance the risk for the informed investor looking to make money on oil prices.