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What is 'Oil ETF'

Oil ETF is a category of exchange-traded funds that invest in companies engaged in oil and gas discovery, production, distribution and retail. Some oil ETFs may be set up as commodity pools, with limited partnership interests instead of shares. These community pools invest in derivative contracts such as futures and options.

Among the largest oil ETFs in the U.S. market are United States Oil Fund (USO), Vanguard Energy ETF (VDE), Alerian MLP ETF (AMLP), and Energy Select Sector SPDR ETF (XLE).

BREAKING DOWN 'Oil ETF'

An oil ETF offers advantages to those who want to participate in oil markets and reap the potential rewards without the logistics of handling actual fuel products. Most investors, especially individuals or smaller operations, don’t have the capability to obtain and store actual supplies of crude oil in inventory. With an oil ETF, the investors are dealing in futures, so physical inventory isn’t a concern. This option provides a convenient way for investors interested in getting into the oil market to participate.  

The benchmark target for an oil ETF may be a market index of oil companies or the spot price of crude itself, and funds may be focused on just United States-based companies or may invest around the world. There are even inverse ETFs for oil and other sectors that move in an equal and opposite direction to the underlying index or benchmark. Oil ETFs will attempt to track their relevant index as closely as possible, but small performance discrepancies will be found, especially over short time frames. 

Investing challenges of Oil ETFs

Oil ETFs have a high level of demand from investors because oil is such a pervasive commodity in the modern global economy, and that trend is only likely to increase. Almost every end product used by people, companies and governments is in some way affected by the price of oil, either as a raw component or through the costs of energy, transportation and product distribution.

However, investing in oil ETFs can be tricky and complicated, because so many fluctuating factors impact the market, and these conditions can be tough to predict. The market is constantly adjusting, and global political events and environmental conditions can have significant and unexpected effects on this market. Given the volatility, this area may be a better fit for investors who have their eye on quick, short-term results and who are prepared for quick reactions rather than those more concerned with a long-view approach.

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