Tune out Greed and Panic – Things to learn from the current Oil fiasco

Tune out Greed and Panic – Things to learn from the current Oil fiasco

Changes in the markets can tempt you to make emotional decisions. Instead of giving in to greed and panic, you need to educate yourself. Greed is a fear of losing out. Conmen like Bernie Madoff got people's money by saying: You don't want to miss out on easy money. Panic is fear of losing what you have. A stock starts going down and you want to sell before you lose any more. This makes you buy and sell out of fear.

I've never met anybody that makes a lot of money because they panic better than everyone else. If you panic, you're not making logical decisions. It's part of our human nature to have those emotions.

But we can rise above those impulses.

Let’s begin by understanding these terms:

  • Stock is ownership of a company.

  • A bond is short for bondage. If you buy a corporate bond from Apple, you loan your money to Apple.

  • An option is an agreement where one guy makes a promise to buy or sell and the other guy has a choice.

  • A future is almost like an option, except here is this guy makes a promise to buy something and this guy makes a promise to sell it.

  • An exchange-traded fund (ETF) sells shares but the fund owns and controls the underlying assets.

Now let’s look at the current oil crisis. You’ve probably heard oil prices went negative and everyone asks: How is that even possible? We're in a market environment that's different than any other because airlines are not flying; bus stations are closed and people are not driving. So demand is down and we have millions of barrels of oil out there.

In this future contract, one guy buys oils for $20 a barrel. If it goes to $25 a barrel, he’s in nice shape. But if the price of oil suddenly goes to $15, he's paying $20 and losing $5 a barrel. Why is this happening? Because people with futures are panicking and liquidating.

How much do you think it costs to get that oil drill and pump going in the middle of the Gulf of Mexico? You can't just turn off your pump. You can’t dump or burn oil because it's an environmental hazard. It is toxic, smelly and flammable. You also can’t keep oil forever. In many cases, these oil companies can and will go bankrupt. That means more people laid off work.

Here is another term for you. Contango is normal pricing that assumes an asset or a commodity is going to get more expensive in the future.

If you've ever traded options, you're going to pay for your ability to lock in a price in LEAPS – long-term equity anticipation securities -- for a month, a year or two years.

Here’s another term for you: backwardation -- backwards of the normal. When would the short term be more expensive compared to the longer term? When there's not enough supply of oil.

Imagine that war breaks out. Prices are going to go up short term because everyone needs oil. That's literally the opposite of what we have right now.

When this contango becomes very, very severe, they can call a super contango.

Consider the United States Oil Fund

A lot of people think: I'll just buy USO at $3 or $4 and participate in this huge recovery, because I know oil is going to go back to $40 or $60 a barrel.

The problem is that USO holds the futures contracts. Futures expire. Whatever they buy, they have to sell. Someday, the USO will disappear because it is losing a lot of value.

It’s replacing a barrel of oil with a barrel of oil, but they're losing massive amounts of money every time they roll those contracts forward. USO is a very dangerous asset because it's literally just bleeding capital. We might see the government step in, which would not be unprecedented because they pay farmers not to farm all the time.

If the world doesn't start to normalize, this can be an ongoing issue. We're not necessarily out of the woods next month because we've got to use that excess oil.

Maybe that little voice inside your head says: I'm going to short this.

Let’s go back to that greed I started with the beginning. “I'm going to short this.” Do you think other people might have thought of that before you? If you go heavy and short on this and it does have a spike relative to where you are, it can hurt you.

If there was ever a time for someone to get serious about their financial education, when would it be? It would have been six months ago or a year ago, but you can't go back in time.

You can put your head in the sand and just pray and hope things work out.

Or they can start to learn. You can read Stock Market Cash Flow: Four Pillars of Investing for Thriving in Today’s Markets.

If you're not in the Four Pillars class, get there. If you don't understand options, get there. Make sure you understand what you're doing; make sure you understand what your trade, If you feel like now's the time to get smart, then come to the Cashflow Academy and see what we have. We would be delighted to help teach you.

Original publish date: June 22, 2020