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As Brent Crude's Popularity Grows, Should You Dump USO?

By The Financial Lexicon | Fri, 07 December 2012 19:16 | 0

In the recent Bloomberg article, “Brent Favored Over WTI Oil by U.S. for First Time,” the authors discuss the EIA’s decision to drop WTI crude in favor of Brent crude as the reference oil price in its “Annual Energy Outlook 2013.”  The article also noted that daily trading volumes year-to-date for ICE Brent futures and NYMEX WTI futures are nearly identical at 560,149 contracts and 567,583 contracts respectively (through December 5).  In percentage terms, the number of contracts traded on Brent futures has never been this close to overtaking WTI futures over the course of an entire year.

Non-futures oil traders may be accustomed to trading the popular United States Oil Fund (USO).  It tracks the front month WTI light, sweet crude oil contract trading on the NYMEX.  Over the past 90 days, USO has averaged 7.9 million shares per day, a number that certainly puts it among the most actively traded exchange-traded funds tracking commodities.  But if Brent crude is the wave of the future, is there an exchange-traded product available for investors who want to track a better benchmark for global oil supply and demand?  Yes, there is.

The less popular United States Brent Oil Fund (BNO) is designed to track the price of the front month Brent crude oil contract traded on the IntercontinentalExchange (ICE).  When the contract is within two weeks of expiration, however, it is rolled over into the next closest to expire contract.  A few other points of interest regarding BNO include:

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1.       The average daily volume over the past 90 days is 40,267 shares.  This fund is clearly not yet as widely used as USO.

2.       BNO does have an option chain.  The volumes, open interest, and depth on the bid and ask prices certainly leave something to be desired.  With that said, given the lack of trading volume on both BNO and its option chain, I expected the bid-ask spreads on the front month at-the-money options to be much wider than they are.  I’ve seen far wider spreads on ETFs with comparable volumes.  If you are fortunate enough to find some hidden liquidity between the bid price and the ask price, you might actually get a respectable fill.  That is not something I can say for many other less popular exchange-traded products.  For more information on hidden liquidity, please refer to Chapter 7 of my new book, The 5 Fundamentals of Building a Retirement Portfolio.

3.       The expense ratio is 0.95%.  USO’s is 0.74%.

Should you abandon USO in favor of BNO?  Not necessarily.  It all depends on what you are hoping to accomplish by trading oil.  If you are playing the WTI-Brent spread, you will want to own USO over BNO when trying to take advantage of a narrowing spread, and own BNO over USO when trading a widening spread.  You may even find it useful to own one fund while simultaneously shorting the other.  Additionally, the slope of both WTI’s and Brent’s futures curves will also play a role in deciding which fund to be long.  Given the negative effects that contango has on a futures trader’s returns, taking contango into account when deciding which fund to trade is a must.  Also of importance is to note that USO and BNO are quite correlated from a directional standpoint.  Where they differ is in terms of the magnitude of the directional price moves.  Finally, expenses are something that should not be ignored.  USO offers both a lower expense ratio and consistently narrower spreads than BNO (for the share prices and the option chains).  Keep in mind that wide bid-ask spreads are a type of transaction cost.

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If Brent crude oil continues to make headway in the trading community, then it is likely that BNO’s popularity will grow over time.  But just because a fund is not popular right now doesn’t mean you shouldn’t trade it.  Keep BNO on your oil trading radar screen.  It is a good alternative for those investors looking to trade a crude oil benchmark that seems to better reflect global supply and demand. 

By. The Financial Lexicon

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