Financial Innovation Meets Oil Investing

With oil rising like it has it certainly isn't hard to imagine oil investors making out like bandits. Take the investors who bet on the price of oil directly, thereby cutting out the risk of owning individual oil companies. Let's see how they have done so far.

United States Oil Fund

Fund Inception Date: 10-Apr-06

The investment seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil.

WTI Spot Price on April 12, 2006: 68.53
WTI Spot Price on November 3, 2009: 79.58

That's a 16.1% gain.

USO Price on April 12, 2006: 67.84
USO Price on November 3, 2009: 40.62

That's a 40.1% loss.

So what went wrong?

The fund will invest in futures contracts...

And why is that not a good thing?

Zero-Sum Game

Options and future contracts are examples of zero-sum games (excluding costs). For every person who gains on a contract, there is a counter-party who loses. Gambling is also an example of a zero-sum game.

Zero-sum games are not known for their ability to keep up with inflation long-term. Unlike investing in general, for each winner in derivatives there MUST also be a loser. There is no rising inflationary tide that can lift all boats.

That said, USO investors managed to go that extra mile. They actually managed to lose a lot of money betting on the rising tide of oil and being right. Apparently the "losers" on the other side of the trade wanted to be paid a hefty premium to take the losing bet.

Similarly, betting on the favorite ("sure thing") at the horse track each and every day of your life isn't going to improve your odds of keeping up with inflation either. Go figure.

Is it any wonder why I hoard toilet paper? It's not a zero-sum game, I'll tell you that much. In theory, all toilet paper prices can rise together. We can all be winners if and when inflation really does pick up. Hurray!

Sigh.

Source Data:
Cushing, OK WTI Spot Price FOB (Dollars per Barrel)
USO Historical Prices