How To Trade Oil And Gas (Part 2)

Oil, gas and other energy news is everywhere, but how can you actually get started with investing in all this? Read on and find out.

You might be thinking about using stocks, ETFs, CFDs or futures to trade oil and gas. Well, picking the right instrument depends on many factors, like types of businesses, regions, risk profiles, and psychology.

In the first instalment we focused mainly on non-leveraged securities (stocks and ETFs) linked to the energy industry by showing some stable and/or fast-growing stocks and indexes. The second part is devoted to leveraged instruments like CFDs and futures contracts.

Contracts For Difference (CFDs) And Fraction Of Stocks

A Contract for Difference (CFD) is an OTC (over-the-counter) derivative contract that is replicating the price moves of its underlying asset. Many retail brokers offer those contracts, allowing to trade a wide range of products (including forex, indexes, commodities and now stocks). Such OTC contracts were banned in the U.S. due to the fact that trades are not passing through regulated exchanges. In Europe they are allowed, even though a broker that offers them has to comply with a layer of regulations which were put in place by the European Securities and Markets Authority (ESMA) a few years ago. These regulations were notably set to limit the leverage (as some brokers were previously offering up to 1:200 or 1:500 leverages), consequently increasing the margin requirements, and – this is, in my opinion, something that turned out to be their main advantage – to offer guaranteed stops!

Indeed, those “guaranteed stops” switch the execution risk into the broker’s side. Since the execution of such stops is guaranteed at the set price, you don’t worry too much about any slippage. Another advantage of trading CFDs is that you can decide which fraction of your capital you want to allocate to your trade since those are non-standardized contracts. Therefore, if you are a beginner, you can trade mini (0.1) or even smaller micro-contracts (0.01). This specificity allowed many brokers to offer their retail clients the option to invest in a fraction of stocks. So, let’s say you’ve got a $5,000 portfolio, and you want to buy an Amazon (NASDAQ:AMZN) share that is currently trading at $3,300.

Thus, if you bought one full stock at that price, then it would mean that two-thirds (66%) of your portfolio would be exposed to Amazon’s stock price fluctuations, and you wouldn’t have the possibility to get a good diversification ratio. But if you were able to buy a custom-made fraction of that share, then you could potentially decide that you just want to invest in 1/6^th of that Amazon stock. By doing so, you would only have $550 of your portfolio exposed to Amazon’s stock price fluctuations, which is an 11% risk in equity instead of 66%!

Futures Contracts

Futures contracts are standardized (centralized) derivative contracts allowing traders to obtain fairly good liquidity when they place trades through regulated exchanges. Furthermore, they can trade with certain leverage, which implies some margin requirements. Given the fact that margin requirements that allow to trade full futures contracts may be a barrier to retail traders, the main exchanges have created new products to decrease their margin requirements, allowing traders to get smaller exposure and better size their position. This helps hedgers get a more accurate hedge when they cover their physical trades, notably with the use of currency E-Mini/E-Micro futures contracts to cover the exchange risk.

So, it goes without saying that futures attract more and more players to take part in the markets.

Regarding the energy sector in particular, at Sunshine Profits we set our focus on the main energy futures contracts, like West Texas Intermediate (WTI) Crude Oil (CL) and Henry Hub Natural Gas (NG), but occasionally we may also look at the Brent Crude Oiland the petroleum refined products such as Reformulated Blend-stock for Oxygenate Blending (RBOB) Gasoline (RB), Heating Oil (HO), Low Sulphur Gasoil (G), Carbon Emissions, etc.

If you want to get some exposure to energies with less leverage, we are going to provide you with some ETF trackers which are highly correlated in the table below, with pros & cons:

In conclusion, in this series, we explored not only all the different ways to trade oil and gas but also a broader range of products that allow to take advantage of the energy commodity price moves depending on the risk you want to take when trading instruments with bigger or smaller leverage.