Guide to Oil ETFs

NEW YORK (TheStreet) -- Last year when I wrote a guide to oil ETFs, there were 12 options for investors. Half of those were short, double long and double short ETFs, while six were various long strategies. One year later, two of these funds, the MacroShares Oil Up and Oil Down, have closed due to lack of investor interest, while the double long PowerShares DB Crude Oil Double Long ETN(DXO) closed to avoid running afoul of CFTC position limits. United States Commodity Funds also launched a new short ETF product (DNO).

Although it might prove popular, there is still no ETF offering physically backed oil and unlikely to be one. Instead, investors have a choice of several futures backed ETFs or futures tracking ETNs that deliver a range of tax and strategy options.

ETF vs ETN. At the top level, the difference between the ETFs and ETNs lies in their tax status. The oil ETNs are taxed the same as stocks. The holding period determines whether capital gains are taxed at short-term or long-term rates, and the holder can decide when to trigger a taxable event by selling the ETN. ETFs are set up as partnerships and they issue K-1 forms. Gains and losses are taxed at 60% long-term, 40% short-term, regardless of how long the fund is held, based on the gains and losses in the underlying futures contracts. This means a holder is liable for taxes even if they do not sell the ETF.

Along with the difference in tax status comes the credit risk of holding an ETN. These are structure as debt and the credit worthiness of the financial institution issuing the security may have a bearing on the performance of the fund. During the financial crisis, some ETNs traded at discounts due to fear about the solvency of the issuing firm.

Aside from the ETF and ETN distinction, the main differences between the funds are the timing of contract rolls. U.S. Oil(USO), for instance, rolls contracts each month, while PowerShares DB Oil(DBO) follows the Deutsche Bank Optimum Yield Index that opts for the best contract to minimize contango or maximize backwardation.

Long Oil. For going long oil, there are five choices: USO, DBO, U.S. 12 Month Oil(USL), iPath S&P GSCI Crude Oil Total Return Index ETN(OIL), PowerShares DB Crude Oil Long ETN(OLO).

Performance varies with these funds due to contango in the oil futures market. Although less extreme than in 2009, recent contango was enough to cause a 52-week low in USO in May 2010, for instance, despite the fact that oil spot prices have not made a 52-week low. Although not exactly the same, OIL does behave very similarly to USO and also hit a new 52-week low during oil's recent sell-off. DBO and OLO both use the Optimum Yield index, they only differ in that one is an ETF and the other an ETN. Finally, USL also uses a monthly roll strategy, but differs because it holds the next 12 months of oil futures contracts. This allows the fund to reduce the cost of contango and it behaves more similarly to DBO than to USO.