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Last Updated: Tuesday, 7 September, 2004, 04:45 GMT 05:45 UK
Oil investors spread their bets
By Myles Neligan
BBC News Online business reporter

Oil traders, New York Mercantile Exchange
Speculative trading had helped drive up prices
Oil prices may have eased back from their recent highs, but they are still up by more than 30% since the beginning of the year.

And with global production still barely keeping pace with soaring demand, analysts say there is every chance that prices could take off again.

For industrialised oil-consuming countries, sudden price surges of this kind are bad news.

They take money out of the pockets of businesses and consumers that would otherwise be spent on creating jobs or buying goods, acting as a brake on economic growth.

But they present a golden opportunity for investors brave enough to have a bet on the direction of the price.

Investment banks and hedge funds have been doing just that over the past three months.

Indeed, oil producers' cartel Opec - and many independent analysts - believe heavy speculative trading by big financial institutions has itself contributed to the latest jump in prices.

But making money from oil is no longer the sole preserve of Wall Street giants.

Public demand

Last year's surge in oil prices during the run-up to the Iraq war created strong demand for financial instruments which would allow private individuals to profit from oil price rallies.

Several banks have responded with a range of derivative products such as warrants, which give investors the right to buy oil at a pre-determined price at some point in the future.

It's easy to place a bet, but it's just as easy to lose a great deal of money
Alpesh Patel, private investor
But the spread bet has this year emerged as by far the most popular means for private individuals to join in the oil trading bonanza.

Will Armitage at London-based spread-betting firm IG Index says the number of oil transactions the firm handles has gone up "hugely" in recent months.

"Our customers are drawn towards volatility, and nothing has been as volatile as oil this year," he said.

So how do spread bets on oil work?

In a typical scenario, the spread betting firm will tell the investor that it expects the oil price to fluctuate within a range, or spread, for the foreseeable future.

The investor can bet either that the price will rise above that range, or that it will fall below it.

In either case, if he is proved correct, he wins back his stake for every cent by which the oil price breaks out of the quoted range.

For instance, if an investor bets 2 that the price will rise above a quoted range of $40.80 - $40.90 a barrel, and it then jumps to $40.95, he stands to win 10.

Roller coaster

Spread bets therefore offer high returns to those who call the market correctly, and also have the great advantage of being easy to place.

Alpesh Patel, private investor
Alpesh Patel: Betting on a fall
All it takes is an account with a spread betting firm, and a two-minute phone call.

Crucially, they also allow investors to bet on a fall as well as a rise in prices - a highly useful feature in the rapidly changing oil market.

But the catch is that spread betting is particularly unforgiving to those who bet the wrong way.

The investor who calls the market incorrectly must pay the spread-betting firm his stake for each cent by which the price misses the upper or lower end of the range.

In the example above, if instead of rising, the oil price fell to $40.75, the unlucky punter would lose 30.

Unlike the conventional gambler, therefore, the spread better runs the risk of losing not just his original outlay, but many multiples of it.

Experienced investors also warn that because oil prices tend to be highly volatile, the unwary spread better can watch hefty profits turn into massive losses in a matter of minutes.

Playing safe

"It's easy to place a bet, but it's just as easy to lose a great deal of money," said Alpesh Patel, a London-based private investor who has recently been betting that oil prices will fall.

Mr Patel says anyone contemplating a spread bet on oil must first understand historical oil price trends, and even then, should place only a moderate stake.

"The price can go against you, and it can go against you for a long time. You need to be quite clear about why you're placing a bet in the first place," he said.

Luckily, there is a safer alternative for would-be oil investors who lack the nerves of steel required for spread betting.

Oil price rallies are generally accompanied by steady gains in oil company stocks, and this one is no exception.

Anyone who bought BP shares at the start of the year would now be sitting on a 17% profit, and would probably have had far fewer sleepless nights.




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