Take a look at Victoria Bay Asset Management's United States Oil Fund (AMEX: USO).
This famous ETF's benchmark is the spot price of West Texas Intermediate light, sweet crude oil delivered to Cushing, Okla., minus expenses. (I can actually hear some of you who've traded this one vomiting right now.)
The USO said it will invest in energy futures contracts, cash-settled options, and other instruments, including short-term U.S. Treasury securities. Millions of investors thought that this meant that it would track the price of light, sweet crude oil (NYSE:WTI). Can you blame them? When this ETF was launched in April of 2006, it was launched at the exact price that crude oil was being quoted (I think about $69.00).
This was pitched by the media, who said that:
The USO's structure means that investors won't have to pursue such speculation on a contract-by-contract basis through the futures markets themselves. Instead, the USO creates a diversified pool of contracts and provides ease of entry and exit from one's position.
SUPER! But here's what happened if you bought it ...
When Light Crude was quoted right around $69.00 a barrel, this ETF was launched at about $69.00/share. But the ETF started underperforming Crude right away ...
When Crude made it up to $77.95 in July 2006, this ETF only hit just under $75.00 (a 13% gain in Crude and 8.7% for the ETF).
By the end of July 2006, when Crude dropped to about $61.00, this ETF was at $52.46 (an 11.6% drop in crude from $69.00, compared to a 24% decline in the ETF from $69.00).
Then, as Crude tanked down to $50.00, the ETF made it down to $42.56! (a 27.5% drop from $69.00, compared to a 38.3% drop!)
USO was pitched by the media to the world as the ETF to own when you don't know how to trade the actual Crude futures!!
What about the rebound?
Investors who bought USO considered the possibility that maybe USO has larger swings (both up and down) than crude futures do.
Fast forward to Q4 2007...
In early 2007, USO bottomed out at $42.50, when crude bottomed out at only $45.00. Although crude oil hit a recent high of about $89.00/barrel, this ETF only traded as high as $67.00!
USO moved up by 57.68% while crude moved up 97.8%!!
So don't buy USO thinking you own oil. It's just the worst place to be. You lose more on the downside, and you make less on the upside.
You're better off buying deep-in-the-money call options on the energy sector, and on the oil service sector. But wait for that. You'll see a pullback soon.
The Oil Service Holders ETF (NYSEARCA:OIH) or the OSX (which is the oil service index) and the Energy SPDR-ETF (NYSEARCA:XLE) will all pull back sometime soon. If you focus on call options that are 4-6 strike prices in-the-money, and the call options that expire in January 2009, then you just might make a couple hundred percent return on your investment.
I hope I at least saved you from making the mistake of ever trading USO.
Disclosure: none