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People chasing oil buying USO long term are poised for a rude awakening.

Tags: contract

People are jumping in oil (USO) futures these days. Data shows that these buy orders are coming from retail investors (from Fidelity, TD Ameritrade, and similar accounts). People, who are jumping in USO now think that with futures at 2.50 per Contract they will become rich long term when oil recovers.

But they have it wrong. Just by a nature of the USO ETF, they will lose money due to Contango effect.

What does it mean?

Let’s take a brief look how USO operates. USO buys oil futures contracts. But they do not buy them to buy physical oil. They do not want to have barrels of oil stored at their backyard. So what USO does when the contracts are nearing to expiration?

They sell the current contracts and buy next month contracts. And when next month contracts near to expiration, they sell those contracts and roll into the next month, and so on.

And now look at the current quotes of crude oil futures with different expirations.

 

 

CL May contract is at $2.87
CL June contact is at $15.13
CL July contract is at $23.17

As those contracts near to expiration, USO has to sell its May contracts at $2.87 and buy June contracts at $15.13. And as June contracts near expiration, they will sell at $15.14 and buy July contracts at $23.17, and so on. This is a constant erosion of the ETF’s price. Buying USO and staying in it waiting for oil to recover and thus becoming rich is a path to destruction.



This post first appeared on Investing Into Stocks - Hello Suckers!, please read the originial post: here

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People chasing oil buying USO long term are poised for a rude awakening.

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