The United States Oil Fund, LP (USO) is the first oil ETF. Its launch is an important event for energy investors and those interested in ETFs. Here's an excerpt from the fund's S-1 SEC filing explaining its use of futures to replicate the price of oil:
What is USOF’s Investment Strategy?
In managing USOF’s assets the General Partner does not intend to use a technical trading system that issues buy and sell orders. The General Partner does intend to employ a quantitative methodology whereby each time a Creation Basket is purchased, the General Partner will purchase oil interests, such as an Oil Futures Contract for WTI light, sweet crude oil traded on the New York Mercantile Exchange, that have an aggregate face amount that approximates the amount of Treasuries and cash received upon the issuance of one or more Creation Baskets.
As an example, assume that a Creation Basket purchase order is placed on January 2, 2006. If one were to assume USOF’s closing NAV per unit for January 2 is $66.79, USOF would receive $6,679,000 for the Creation Basket ($66.79 NAV per unit times 100,000 units, and ignoring the Creation Basket fee of $1,000). Assume that the price of an Oil Futures Contract for WTI light, sweet crude oil on January 3, 2006 is $66,800. Because the price of oil reflected in these Near Month futures contracts on January 3, 2006 is different (in this case, higher) than the price of oil reflected in USOF’s NAV calculated as of January 2, 2006 (the day the corresponding Creation Basket was sold), USOF cannot invest the entire purchase amount corresponding to the Creation Basket in futures contracts—i.e., it can only invest in 99 Oil Futures Contracts with an aggregate value of $6,613,200 ($66,800 per contract times 99 contracts). Assuming a margin equal to 10% of the value of the Oil Futures Contracts which would require $661,320 in Treasuries to be deposited as margin with the futures commission merchant through which the contract was purchased, the remainder of the purchase price for the Creation Basket, $6,017,680, would remain invested in cash and Treasuries as determined by the General Partner from time to time based on factors such as potential calls for margin or anticipated redemptions.
The specific Oil Futures Contracts to be purchased will depend on various factors, including a judgment by the General Partner as to the appropriate diversification of USOF’s investments in futures contracts with respect to the month of expiration, and the prevailing price volatility of particular contracts. While the General Partner anticipates significant investments in New York Mercantile Exchange Oil Futures Contracts, as USOF reaches certain position limits on the New York Mercantile Exchange, or for other reasons, it will invest in Oil Futures Contracts traded on other exchanges or invest in other Oil Interests such as contracts in the “over-the-counter