Drilling For Profits

FUTURES CONTRACTS
Where's the most obvious place to trade the price of oil? The futures market. The oil contracts traded that affect gas prices is light sweet crude oil traded on the New York Mercantile Exchange (NYMEX). Futures contracts can fluctuate quickly and sharply. If your brokerage firm does not trade futures contracts, you will have to open an account with one that does. Of all the options on playing the move in oil, the most direct way possible is buying light sweet crude oil contracts. The contract itself is rather large as it controls 1,000 barrels of crude, so you will be putting a small amount down and controlling the entire contract. This is the true power of the futures market. Leverage is what allows traders to make a lot of money quickly on relatively small moves in price. The reverse is also true -- you can lose a lot of money quickly.

Crude oil on the NYMEX currently trades in every calendar month. If you look at a futures quote, you will see something like this: CLQ8. "CL" is the ticker symbol for the light sweet crude oil contract. The "Q" stands for August and the "8" stands for 2008.

There is an alternative for those who are not ready or confident enough to trade the full contract. It is called the crude oil mini contract, which is traded on the NYMEX. The mini contract will control only 500 barrels of crude. The minimum tick size is two and a half cents a contract or $12.50 a contract compared to the one cent a barrel minimum tick size, which equals $10 per contract on the full contract. The mini contract has an advantage in that you are still buying and profiting from the move in light sweet crude, but mini contracts do not require you to place as much of an initial margin as the regular contract does.

Still not confident enough to trade a light sweet crude oil futures contract, no matter if that contract is a mini? You can also purchase options on the crude oil futures contract. Options on futures contracts are similar to those on stocks. Your losses are limited to what you paid for the option, but your potential for profit is not capped. Keep in mind that options are wasting assets, and time is their greatest enemy.

STOCKS
Not interested in trading futures contracts? You can trade individual stocks that derive their profit from oil. Begin by looking at sectors that are affected by crude oil. Within these sectors you will need to find the stocks that move higher as crude oil prices move higher.

Integrated oil companies are the total package they produce, refine and sell oil to the public. They go by names like Exxon Mobil (XOM), Chevron (CVX), ConocoPhillips (COP), Royal Dutch Shell, which is an American depository receipt (ADR), and BP (BP). Big integrated oil companies will not directly profit from higher oil prices. So far, year-to-date performance of these big integrated oil companies has not been good. They are all down for the year.

Smaller oil companies will get the bulk of their revenue from the exploration and production of oil. Hess (HES), Marathon Oil (MRO), Anadarko (APC), Occidental Petroleum (OXY), and Murphy Oil (MUR) are examples. These companies will generally profit from higher crude oil prices because they are making more money by charging more for the crude they sell. This group has seen a better year-to-date stock performance versus the big integrated oil companies. Hess is up 25% for the year. Anadarko is up 14% for the year to date. Occidental is up 11%, while Murphy Oil is up 7%.

At the other end of the spectrum are the refiners, which are being hurt by an increase in the price of oil. Refiners will not profit from the price of oil going up. This group has seen better days. Valero (VLO) is down 34% for the year, while Sunoco (SUN) is down 46%. Tesoro Corp. (TSO) is down 55% for the year, and Frontier Oil (FTO) is down 33%. Refiners have been beat up all year and will probably continue to suffer as the price of crude continues to soar.

Oil services are companies that keep those oil drilling platforms working and running properly. They have seen a rise in their stock prices since the price of crude has been going up. Schlumberger (SLB) is up 3% for the year, while Halliburton (HAL) is up 33%. Baker Hughes (BHI) is up 8% for the year.

EXCHANGE TRADED FUNDS
Exchange traded funds (ETFs) are another way to play the move in oil. The ETF you choose will purchase futures contracts so they are not a direct play on the futures market. The goal of the ETF is to move in tandem with the move of the underlying futures contract. In the case of oil, when the price rises, the price of the ETF should also move up. While not directly investing in the buying and selling of the actual oil contract, buying an ETF is an excellent alternative to purchasing futures contracts. ETFs are traded like stocks so they do not have any of the drawbacks or restrictions that can come with buying a mutual fund. If you think the price of oil is due for a downturn, you can short the ETF.

There are a few choices when it comes to trading oil with an ETF. OIL is the ticker symbol for the iPath S&P GSCI Crude Oil Total Return. It is linked to the Goldman Sachs Crude Oil Return Index. The United States Oil Fund (USO) is a commodity pool that purchases futures contracts on the NYMEX and ICE exchanges.

The Powershares DB Oil Fund (DBO) tracks the Deutsche Bank Liquid Commodity Index trading light sweet crude contracts. United States 12 Month Oil Fund LP (USL) tracks the price of light sweet crude oil delivered to Cushing, OK.

There are many choices available to the investor and trader who want to profit from the move in oil. The most direct way is the buying and selling of light sweet crude oil contracts. This solution will not work for everyone and with the risk involved with futures trading, you should make sure you are prepared to enter this volatile market. For those of you who want to buy and sell stocks, you can buy individual companies whose profits are derived from the business of selling oil. Or you could choose to purchase an ETF. Whatever you choose, there are many ways to trade oil.