How To Trade Crude Oil Like a Pro Quant: Strategies For Futures, Options & ETFs

Oil isn’t just another financial market. It’s a physical commodity with its own idiosyncrasies, driven by the intricate dance of supply and demand, storage constraints, and geopolitical forces.

Some financial markets are little more than numerical constructs. But oil is wet, heavy, and takes up physical space. And when that space runs out, weird things happen.

Like in April 2020 when WTI crude oil futures went negative. Not just a little negative. We’re talking negative $37 per barrel. The market was literally paying people to take oil off their hands.

Negative oil prices. Image courtesy of TradingView

I still remember looking at those prices in disbelief. It was a stark reminder that commodity markets play by different rules.

And those different rules create unique opportunities for systematic traders willing to understand them.

Let’s dig into the fascinating world of oil trading, from the markets you can access to the strategies that might actually work.

A Word of Caution

Before we go any further, I should mention that I’m not an oil specialist by trade. My background is in systematic trading of broad market effects, such as statistical arbitrage on global futures.

Oil specialists sometimes spend decades building deep domain knowledge; they understand the nuances of specific crude grades, refinery economics, and global supply chains.

This specialist knowledge is important for two reasons:

1. It helps you understand the tactical trades that commercial players make
2. More importantly for us, it helps you recognize when systematic strategies might break down

For beginners, I’d strongly caution against diving headfirst into oil futures with significant capital. The market is unforgiving, and there are certainly easier games for beginners to play.

Having said that, there are certain noisy effects that systematic traders can harness without deep specialist knowledge, at least on average.

Now, let’s continue.

Understanding Oil Markets

Before we talk about strategies, let’s understand what makes oil markets unique:

• Physical storage dynamics: Unlike stocks or bonds, oil is a physical commodity that costs money to store. This creates unique dynamics between futures contracts of different months.
• Seasonality: Demand fluctuates predictably with seasons (more gasoline in the summer driving season, more heating oil in the winter).
• Geopolitical sensitivity: Oil prices can move dramatically based on events in oil-producing regions.
• Complex supply-demand dynamics: Oil production can’t be turned on and off quickly, leading to periods of oversupply or shortage.

These characteristics make oil markets interesting for traders looking for an edge.

The Oil Market Ecosystem

When people talk about “investing in oil,” they could mean several different things:

Physical Oil

This refers to actual barrels of crude oil. Unless you’re an oil company or a large trading house, you’re not going to be directly buying physical oil.

Oil Futures

Futures contracts are agreements to buy or sell oil at a predetermined price at a specified time in the future. The main benchmarks are:

• WTI (West Texas Intermediate): Traded on CME, delivered at Cushing, Oklahoma
• Brent Crude: Traded on ICE, delivered in the North Sea

• Pros:	Cons:
  Direct price exposure High liquidity Leverage (trade size much larger than margin required) Can be rolled forward to maintain exposure	Risk of physical delivery if held to expiration Requires a futures account Higher skill and experience level required Contango/backwardation affects returns when rolling

Oil ETFs

Exchange-traded funds that track oil prices by holding futures contracts.

Popular ones include:

• USO (United States Oil Fund)
• BNO (United States Brent Oil Fund)
  

  Pros:	Cons:
  Trade like stocks No futures account needed No risk of taking delivery	Tracking error due to futures roll Management fees Often underperform spot oil prices in contango markets

Oil Company Stocks

Investing in companies that produce, refine, or distribute oil.

Examples:

• Major integrated companies (Exxon, Chevron)
• Exploration & production companies (ConocoPhillips, EOG Resources)
• Oil services (Schlumberger, Halliburton)

Oil Options

Derivatives that give you the right (but not obligation) to buy or sell oil futures at a specific price.

 

CFDs (Contracts for Difference)

Derivatives that track oil prices without ownership of the underlying.

• Pros:	Cons:
  Easy access Leverage No expiration issues	Not available in all jurisdictions Counterparty risk Higher spreads than futures, typically Funding costs for holding positions overnight, which can fluctuate significantly

  If you choose to trade CFDs, find the best platforms to trade oil here.

The Great Oil Price Crash of 2020: When Oil Went Negative

Let’s take a closer look at what happened in April 2020 when oil prices went negative, because it perfectly illustrates how physical constraints drive oil markets.

Oil’s journey from the ground to the gas tank is a complex logistics operation:

When oil gets pumped out of the ground, it flows through a complicated network of transportation and storage. The crude moves from wellheads to storage tanks, then to tankers, then to more storage, and finally to refineries via trucks and pipelines.

Oil transport and storage

Here’s the critical part: the ownership of the oil is often separate from the ownership of the storage and transportation infrastructure. Oil owners rent space in tanks and book capacity on pipelines and ships.

These arrangements are governed by strict contracts with specific timeframes:

• “You will supply me 100 barrels between day 1 and day 10”
• “You will store my oil between day 10 and day 15”
• “You will transport it from A to B between day 15 and day 30”

These contracts often come with heavy penalties for delays.

Now, imagine what happens when a global pandemic suddenly crushes oil demand by about 30%. People stop driving. Planes stop flying. Factories reduce output. The world simply doesn’t need as much oil.

But here’s the problem: oil production can’t just turn off overnight. Wells were still pumping millions of barrels daily into a system with nowhere to go.

Storage tanks filled up rapidly. Every available tank, ship, and even rail car was commandeered for storage. By mid-April 2020, Cushing, Oklahoma (where WTI futures contracts settle), was nearly at full capacity.

And then came the perfect storm: the May WTI futures contract was about to expire. Traders who held these contracts would be obligated to take physical delivery of oil at Cushing – oil they had nowhere to store.

Suddenly, traders who never intended to take physical delivery were scrambling to sell their contracts at any price. But there were no buyers. Everyone knew there was no available storage.

As expiration approached, desperation set in. Traders began paying others to take the contracts off their hands, pushing prices below zero. The message was clear: “I’ll pay you to deal with this problem because it will cost me even more in penalties and logistics nightmares if I have to deal with it.”

On April 20, 2020, the May WTI contract settled at negative $37.63 per barrel.

This wasn’t about the oil being worthless – it was about the immediate logistical nightmare of having oil with nowhere to put it.

For traders, this event was a brutal reminder that futures contracts represent real commodities with physical constraints, not just numbers on a screen.

Understanding Contango and Backwardation

Before diving into strategies, you need to understand these two market states:

Contango: Future prices are higher than spot prices. This is normal when storage costs and interest rates are factored in.

Backwardation: Future prices are lower than spot prices. This typically happens when there’s immediate scarcity.

Contango vs backwardation

Why does this matter? Because if you’re holding oil through ETFs or rolling futures contracts, the shape of the futures curve will significantly impact your returns, regardless of what happens to spot oil prices.

Now that we’ve covered the basics, let’s look at some systematic strategies.

Strategy 1: Crack Spread Arbitrage

The “crack spread” represents the difference between crude oil and refined products (gasoline and heating oil). It’s essentially the profit margin for refineries.

Economic Rationale

Refinery profit margins follow seasonal patterns and tend to mean-revert around actual processing costs. This creates predictable patterns you can trade.

Implementation: The 3:2:1 Spread

There are many ways to trade this idea, but the classic trade involves creating a spread from:

• Long 3 crude oil contracts
• Short 2 RBOB gasoline contracts
• Short 1 heating oil contract

This ratio approximates the output from refining three barrels of crude (normally, you’ll adjust the prices so that they reflect the same units).

You then long the spread when it falls below its average value, and short the spread when it rises above it.

Performance

Here’s a chart of a crack spread created using historical futures data:

You can see that prior to about 2000, the spread was quite stationary, implying that it could have been traded using simple spread trading rules.

After that, you can see that the spread started to drift, so you need to be smarter with your implementation (perhaps normalizing the spread somehow, or coming up with a different ratio).

Strategy 2: Calendar Spreads

Calendar spreads are among the most versatile tools in an oil trader’s arsenal. At their core, they’re dead simple: you simultaneously buy and sell oil futures contracts with different expiration dates.

For example, you might buy December WTI crude and sell June WTI crude in the same transaction. This creates a position that profits from the relative price movement between these two contracts rather than from outright price direction.

Calendar trade

Why is this useful? Because it lets you strip away some of the noise of the broader market and focus on structural forces that drive the relationship between different contract months.

In oil markets, these calendar spreads tell you a ton about what’s happening in the physical market:

• Storage economics: When far-dated contracts trade higher than near-dated ones (contango), it reflects the cost of storing oil. The spread should theoretically equal storage costs plus interest. When it’s wider than that, traders can profit from the expected reversion (of course, there may be very good reasons for the spread to be wider than that – hence that specialist knowledge we talked about earlier).
• Supply scarcity: When near-dated contracts trade higher than far-dated ones (backwardation), it signals immediate scarcity. The market is saying “we need oil now, not later.”
• Seasonal patterns: Certain spreads capture predictable seasonal demand patterns. For instance, the December-to-March heating oil spread typically widens as winter approaches.

The beauty of calendar spreads is their versatility. You can use them to:

1. Make directional bets with less risk: If you think oil prices will rise but don’t want full exposure to market volatility, you might go long a deferred month and short a nearby month in backwardated markets (or the reverse in contango).
2. Exploit storage economics: When futures prices exceeds storage costs, sophisticated oil traders can buy physical oil, sell futures, store the oil, and deliver against the contract for a risk-free profit (assuming they have access to storage).
3. Hedge production or consumption: Producers can use calendar spreads to lock in price differentials across their production timeline without taking a view on absolute price levels.
4. Trade seasonal patterns: Winter heating oil demand, summer driving season, and refinery maintenance periods create reliable seasonal patterns in certain spreads. These are the sorts of trades that systematic traders should think about.

Calendar spread options take this concept a step further. Here, you’re trading the options on these spreads rather than the spreads themselves. For example, you might buy a six-month call option and sell a three-month call option at the same strike price.

Strategy 3: Cointegration Pairs Trading

This strategy exploits the relationship between different oil benchmarks.

Economic Linkage

Brent/WTI spreads tend to mean-revert due to arbitrageable transportation costs. When the spread gets too wide, traders can physically move oil to capture the difference (minus transportation costs).

Some research suggests that trading a mean-reverting spread on the two benchmarks would have been a profitable strategy from 1993-2022.

The hypothesis for why this works is that there’s a physical arbitrage opportunity – if the spread gets too wide, traders can literally buy oil in one location and sell it in another, minus transportation costs.

Strategy 4: Seasonal Pattern Exploitation

Oil markets exhibit clear seasonal patterns driven by inventory cycles. For example, OECD inventory draws and builds create predictable summer/winter spreads.

Seasonal trades are among my preferred strategies for independent systematic traders – they’re simple, easy to understand, driven by predictable real-world dynamics, and are hard to mess up.

November-March Spread

Research suggests that going long December futures and short April futures captured a significant edge from 1983-2017, with a seasonal return of approximately 1.32% monthly from November to March.

This strategy is effective because the physical reality of seasonal demand generates predictable price patterns that persist year after year.

Strategy 5: Refinery Utilization

This is a somewhat speculative idea, but it might be worth testing out.

Related to the crack spread idea above, this idea exploits the relationship between refinery utilization rates and crack spreads.

The idea is that when the EIA reports refinery utilization below 85% or above 95%, crack spreads tend to move predictably in the following weeks.

Implementation

• Low utilization: Go long crack spreads
• High utilization: Go short crack spreads

This may be effective because low utilization typically signals maintenance or unplanned outages, reducing product supply and widening spreads. High utilization signals ample capacity, which can put pressure on margins.

Practical Considerations

Now that we’ve covered some strategies, let’s talk about practical implementation:

Account Requirements

For futures trading, you’ll need:

• Futures-approved brokerage account
• Sufficient margin (typically $5,000-$10,000 per contract)
• Understanding of contract specifications

For ETFs:

• Standard stock brokerage account
• Awareness of roll yield and tracking error

Risk Management

Oil is volatile. Period. A few guidelines:

• I like to size my positions based on how much volatility I want the position to deliver to my portfolio, based on how much volatility has realized recently.
• Understand the leverage you’re using and how it amplifies your returns, both positive and negative
• Have a plan for extreme scenarios (like negative prices!)

Trading Hours

CME WTI crude futures trade:

• Sunday – Friday: 6:00 PM – 5:00 PM ET (electronic)
• Monday – Friday: 9:00 AM – 2:30 PM ET (open outcry)

Liquidity is highest during US market hours.

Tax Considerations

Futures contracts receive favorable 60/40 tax treatment in the US (60% long-term, 40% short-term capital gains), which can be advantageous compared to ETFs taxed as ordinary income.

Recommended Approach for Beginners

If you’re new to oil trading, here’s my suggested path:

1. Start with ETFs: Get familiar with oil price dynamics without the complexity of futures
2. Study futures curves: Understand contango and backwardation
3. Start small: Keep your position sizes small
4. Focus on simpler strategies: Seasonal and spread trades are more forgiving
5. Diversify: Don’t put all your capital in oil trades

ETF Considerations for Beginners

If you’re starting with ETFs, be aware of their limitations:

USO, the most popular oil ETF, has historically underperformed during periods of contango because it must constantly roll futures contracts to maintain exposure.

USO returns (maroon) vs CL futures returns. Image courtesy of TradingView

During the 2020 oil crash, USO was forced to change its structure completely because it owned nearly 25% of all front-month WTI contracts – a dangerous position as expiration approached.

Alternative ETFs like USL (which holds a basket of 12 months of futures contracts) may provide better long-term exposure with less sensitivity to short-term price moves.

Final Thoughts

Oil markets offer unique opportunities for systematic traders willing to understand their peculiarities. The strategies I’ve outlined are backed by economic rationale and empirical evidence, but they still require discipline and risk management. You should consider these ideas as a starting point for your own research – don’t just blindly trade them.

Remember, oil is a physical commodity with physical constraints. This creates inefficiencies you can exploit, but also risks that can blow up your account if you’re not careful.

The one constant in oil markets is surprise. Be prepared, be disciplined, and respect the mayhem.