Oil ETN Liquidity - Long and Short

By Brad Zigler

Despite the economic slowdown, there are still some growth businesses. Take manufacturing, for instance. No, not auto or widget making. I'm talking about the manufacturing of exchange-traded portfolios.

You've no doubt noted, in particular, that the number of exchange-traded notes and funds tracking the Oil market has ballooned. Which inevitably leads to questions on their performance. Especially in these credit-addled times, questions abound about exchange-traded notes.

So here's the quick-and-dirty. There are three long and two short notes. The original long note was the iPath DJ-AIG Crude Oil Total Return ETN (NYSE Arca: OIL). It's been around a couple of years and is an obligation of the U.K.'s Barclays Bank plc.

Then, with near-perfect timing, the PowerShares suite of oil notes was launched this summer, just in time to catch the swoon in oil prices. These notes, offering single and double exposure - short and long - to the Oil sector of the Deutsche Bank Liquid Commodity Index, are issued by the German bank's London branch.

Spot NYMEX oil has sunk 71.7% since the PowerShares notes' launch. Here's how the notes have responded:

OIL ETN Performance (7-Jul-08 through 17-Dec-08)

Note	Ticker	Return	Volatility	Current Spread	Liquidity Index	Average Volume
iPath DJ-AIG Crude (1x Long)	OIL	-69.6%	62.2%	0.04%	569,000	617,000
PowerShares DB Crude (1x Long)	OLO	-61.4%	55.8%	1.65%	5,700	13,700
PowerShares DB Crude (2x Long)	DXO	-88.8%	133.7%	0.36%	461,400	3,893,000
PowerShares DB Crude (1x Short)	SZO	155.2%	47.1%	3.25%	1,900	7,000
PowerShares DB Crude (2x Short)	DTO	455.7%	88.1%	0.43%	62,400	553,700

From the table, you can easily see the short notes have fared well. The interesting numbers, however, have to do with liquidity.

The spread between the bid and offer is typically the best indicator of liquidity. A tighter spread denotes a more liquid market. Clearly, the more mature OIL portfolio has the advantage over the OLO portfolio.

The levered notes, too, are more actively traded and more liquid. This most likely reflects the utility of these securities as hedging alternatives to futures as well as outright portfolio positions.

Also notable is the liquidity index reading for each note. The index is a volume-weighted metric that tells you the size of a trade - all else held equal - needed to move the note market one percentage point. The higher the number of notes, the more liquid the market.

Of course, all things aren't always held equal. The notes' market makers must track the underlying index with their bids and offers to keep arbitrage opportunities from opening up. You don't have that in regular old stocks.

But if you're trading oil ETNs, you probably think plain old stocks are boring, right?

OIL ETN Performance

Comments

[Hedged In:]

Useful data (and good article). The key point:

"The spread between the bid and offer is typically the best indicator of liquidity. A tighter spread denotes a more liquid market... The levered notes, too, are more actively traded and more liquid."

The reason may not be due to their use as hedges, but rather due to the exploding popularity of levered ETFs and ETNs generally. For example, look at the trading volume of the relatively new TZA.

2008 Dec 18 05:34 PM

[Hmm?!:]

Why did you leave out OIL and DUG which have 8-10 times the volume of your examples?

It makes me question your motives for this article.

2008 Dec 19 09:09 AM

[Jack Walker:]

Brad,

Thanks of this informative and well-prepared article. The addition of OIL and DUG along with perhaps USO would be welcome additions.

Jack

2008 Dec 19 12:14 PM

[Chris B:]

I find it interesting that the long oil ETFs have higher volume than their short counterparts - even during a period of collapsing prices.

Does this tell us that most oil investors have been betting on higher prices and losing their shirts for the past 6 mos? Or does it tell us that going long oil has a portfolio function that going short does not - a hedge for a high-dividend transportation stock for example. That theory has an obvious hole in it: why wouldn't the short funds be equally good hedges for dividend-paying oil stocks?

An observation that could resolve the confusion is that volume in DXO has been skyrocketing in the last couple weeks, while volume in DTO has declined. This can be interpreted in 2 ways: refusal to sell short positions and capitulation on long positions or as most participants shifting from short to long, even as the underlying contracts are driving prices.

Bonds or TIPs would be much safer and saner, but if you want to swing for the fences with some speculative money, go DXO at $20.

2008 Dec 19 12:33 PM

[bobbobwhite:]

At under $40 a barrel, don't know how much longer it will make sense to be in oil short ETFs. At $140 it was fine, and all the way down, but now it seems to be scraping the bottom of the "barrel", and that's typically where hogs get slaughtered trying for that last dime of profit. I think oil prices are too low now and will rebound sharply next year.

Just out of SZO today, a 1X oil short.

"Forget the first 20% of a stock's run and the last 20%, and take the middle 60%." Sound advice by star investment pros I always follow.

2008 Dec 26 11:25 AM

[relmor:]

Yes, if oil drops 60 percent from it high, you made 120 percent going short....Now if you swithc that to long...so if you owned a short from 100 to 50, thats a 100 percent gain a double short....Go to a single long from here, watch as oil rebounds....then switch to a double long to catch the middle ground....I wouldnt go double short or long as it finds a top/bottom...etc....

2008 Dec 27 01:36 PM

[relmor:]

Im in at DXO at 1.97, using 35 dollar oil as a swing position.... I feel at some point, oil will be back over 35 dollars a barrel, regardless if it fails further from here.....Where is the money on oil to be made now....Up or down.... Well....If Obama gets his infrastructure wishes, it looks like long to me.......

2008 Dec 27 01:38 PM

[Brad Zigler:]

No ulterior motives here. OIL was, in fact, included. It's the ETN that tops the table.

DUG wasn't included for two reasons: 1) It's not an ETN. It's, instead, an ETF. 2) It tracks an oil and gas EQUITY index, not spot oil or oil futures. We'd be comparing apples to kumquats if DUG was included.




On Dec 19 09:09 AM Hmm?! wrote:

> Why did you leave out OIL and DUG which have 8-10 times the volume
> of your examples?
>
> It makes me question your motives for this article.

2008 Dec 28 06:37 PM

[Brad Zigler:]

Read my comment on OIL and DUG above. USO wasn't included because it's not an ETN either. It's technically a commodity pool that holds actual futures.

The ETNs are (or should be anyway) devoid of tracking error because they're not actual portfolios of phayical assets. Getting rid of tracking error means you take on credit risk, however, as the ETNs represent debt obligations of the issuer.


On Dec 19 12:14 PM Jack Walker wrote:

> Brad,
>
> Thanks of this informative and well-prepared article. The addition
> of OIL and DUG along with perhaps USO would be welcome additions.
>
>
> Jack

2008 Dec 28 06:42 PM

[newbie21:]

Brad, very informative article. Thank you. Is there a such thing as a "reset date" in DXO? In other words, at what point do you make or lose money?

2008 Dec 31 02:23 AM