Profiting From The Rise In The Price Of Oil

As I mentioned 5 weeks ago when oil breached $115/barrel, demand for the black gold will cause the price to keep on rising. On Wednesday, I drove to USC where I had an interview at the Marshall School of Business for the full-time MBA program. While driving there, I heard that Oil had exceeded $133 per barrel. I had a great interview (where I spoke about my background, my interests, the state of the economy, what a moron George W. Bush is, and the current elections) and then proceeded to a friends’ place to spend the night.

I later heard that oil prices hit $135/barrel. That news was broadcast incessantly on all the news channels and I kind of felt that it was being overdone. Whenever everyones saying that the price of something is breaking all records, it usually pulls back. I think thats why the US Dollar had shown some strength this year. I woke up on Thursday and bought the ULTRASHORT OIL & GAS ETF (AMEX: DUG), it went up a dollar and I exited my position, happy to have made enough money to pay for my gasoline bill for this month.

After that I went to UCLA for a class visit. I attended a class on Risk Management. One of the case studies they discussed was a deal between Amoco (American Oil Company, which is now part of British Petroleum) and Apache (APA) involving the sale of an oil producing property. Amoco sold the property with a guarantee to pay Apache a certain amount of dollars if the price of oil dropped below a certain amount. On the other hand, they would participate in some of the profits if the price of oil exceeded a certain amount. This was managed through the use of Put and Call Options.

It was interesting to see how large companies managed to hedge the price of oil through options, and especially ironic since oil was all over the news that day. Its not too different from how you can hedge your own expenditures on gasoline and heating oil. If you’re bullish on the price of oil and are willing to bet on this movement, you can buy the United States Oil ETF (USO). You can also buy options on this too.

Similarly, if you’re bearish you can buy the ULTRASHORT OIL & GAS ETF (DUG). You can also invest in Oil Futures contracts, however, if you’re that brilliant I doubt you’d be reading this blog!

But making directional bets in any asset class requires a certain amount of knowledge, homework and commitment. Its much easier to invest in high-yield Canadian Income Trusts like ERF, PGH, AAV, HTE, PEY-UN.TO, etc. They pay out a pretty good dividend (over 8% for most of them) and that should theoretically go up as the price of oil & gas goes up. (I say theoretically since there is some uncertainty regarding the Canadian Governments’ taxation of these trusts, so there is a black cloud hanging over them).

So far I’ve been pretty happy with my investments. I had been buying more on dips. For those of you lucky enough to have bought AAV under $9 back in January, in addition to the monthly dividends, you’ve already seen a 40%+ appreciation in the stock price! (unfortunately I wasn’t one of the lucky ones!)

But there are many ways to profit from the economic news if you keep your eyes open. By the way, USC called me on Friday. I got admitted to their MBA program with a Fellowship (tuition remmission)! So now it’s time to decide between UCLA, USC and UCSD!