Daily Gains Letter

How to Protect Your Portfolio from Fluctuations and Profit from Rising Oil Prices

By for Daily Gains Letter |

Protect Your Portfolio from Fluctuations and Profit from Rising Oil PricesNot too long ago, the per-barrel price of oil was hovering close to $85.00. Now, a few months later, it trades above $107.00; this is an increase of roughly 25% in a fairly short period of time.

One may ask why this matters, and what it means for the overall U.S. economy.

At the most basic level, the price of oil has a very deep impact on consumer spending, which makes up 70% of the gross domestic product (GDP) of the U.S. economy. It impacts consumers in two ways.

First, let this be clear: while the average American Joe doesn’t use crude oil in raw form, he does use it in the form of gasoline in his car. Oil and gasoline prices have a direct relationship; together, they shrink the size of consumers’ pockets. When oil prices increase, consumers end up spending more at the pump and less on goods they want to buy. Note the black line in the chart below: it shows gasoline prices per gallon, and their movement along with oil prices.Take a look at the chart below to get a better idea about surging oil prices:

Light Crude Oil Chart

Chart courtesy of www.StockCharts.com

Second, when oil prices increase, they cause the transportation costs to go higher as well. Eventually, the increased costs are transferred to customers; this makes goods and services more expensive, and their dollar buys less than what it did before.

So how can investors profit from increasing oil prices?

When oil prices go up, different sectors react in different manners. This means some are highly affected, while others, not so much.

Consider the airline industry: what will happen to its profitability if the price of oil goes up? The higher oil prices can increase their cost to fuel airplanes, reducing their profitability. Once this happens, their stock price will likely portray this and decline. One strategy investors can employ is to short airline companies when the price of oil spikes higher.

They may also make money by shorting companies that are in the transportation business in general, because increasing oil prices increases their costs and decreases their profitability.

For those who want to keep their investment strategies simple, they can profit by looking at exchange-traded funds (ETFs) like United States Oil (NYSEArca/USO). This ETF mimics oil prices; if the price of oil goes up by one percent, it does the same.

Investors must keep in mind that the recent surge in oil prices is due to tensions in Egypt. This can all change very quickly, and the prices can come down. Investors need to continue to use proper risk management techniques so that a minor fluctuation doesn’t cause a huge dent in their portfolio.

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