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A New Way to Trade Oil?


Using options might help minimize performance drift.

It looks like investors might soon be getting new options in ways to invest in commodities. Last week, Standard & Poor's launched the S&P GSCI Crude Oil Covered Call Index in what's likely to be the first of many commodity-based indices tracking the performance of the popular covered-call options' strategy.

The creation of such benchmark indices is usually the precursor to offering other tradable products, most likely a closed-end exchange traded note (ETN) in which individuals can invest.

The concept behind the Crude Oil Covered Call Index is similar to that behind stock-based benchmarks -- such as the CBOE S&P 500 Buy-Write (BXM) index, which helped popularize the use of options in both actively managed funds such as Madison/Claymore Covered Call (MCN) and those that adhere strictly to the methodology of the BXM, such as the S&P 500 Covered Call (BEP). Standard & Poor's is starting with crude oil, as it is the most liquid and widely used commodities market. But they'll likely eventually create similar indices for precious metals, and possibly for agriculture.

While the underlying concept of systematically writing out-of-the money call options against a long position as a means of both reducing volatility and enhancing returns is the same, there are some distinct differences in doing so with commodities vs. equities.

What the Future Holds

The GSCI Oil Covered Call Index will use the futures contracts, not the underlying physical commodity, as the basis for establishing long exposure to the oil market. Unlike stock-based covered-call programs, in which only the options need to be rolled forward, both the long futures and options will need to be rolled.

The index will use the front-month contract of West Texas Intermediate (WTI), which is traded on the NYMEX, and related options; both will be rolled monthly when there's less than 30 days remaining until expiration.
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No positions in stocks mentioned.

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