Oil ETFs and ETNs: More Complicated Than You Think 30 comments
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There are at least three main ETFs that allow the retail investor to buy oil, as in the commodity:
- The United States Oil Fund (USO)
- The iPath S&P GSCI Crude Oil Total Return Index ETN (OIL)
- The MacroShares $100 Oil Up Fund (UOY)
The first two of these essentially buy oil futures contracts, while the latter one essentially represents an economic interest in 1/4 of a barrel of oil. Like its predecessor fund, UOY shares are created as one half of a pair of shares. The other half is the DOY shares, where the D stands for Down. There is a trust structure that basically obligates the UOY shareholders to transfer assets to the DOY shareholders to the extent that the price of oil moves down and vice versa. In other words the UOY and DOY shareholders are always on opposite sides of changes in the price of oil. Whereas the other ETFs derive their value from holdings of futures contracts the UOY/DOY pair derive their value from each other.
The difference in these ETFs has significant implications for the way these funds track the price of oil and this has resulted in some confusion. For instance, as of right now the oil futures market is in a significant state of contango with the March '09 contract settling today at 42.13 while the March '10 contract settled at 56.85. In other words, the futures market expects oil prices to rise by more than $14 per barrel over the next year. However, some have erroneously suggested that investors can profit from this expected increase by buying USO or OIL. If only life were that simple!
The fact of the matter is that if spot oil prices exactly followed the prediction of the futures markets over the next year, then USO would have exactly zero appreciation in that time frame. How is that possible?
Well, USO always owns the front month futures contract and therefore must always roll those contracts over as they near expiration. If spot oil prices exactly follow the futures price curve, then futures contract prices will never change and USO will never profit or lose as they roll over their contracts month after month. In fact, the only way for USO to profit is if oil prices rise by more than what is predicted by the futures market. In other words, USO will only profit if their futures contracts go up in value and that will occur only if oil prices outperform the futures price curve. So you might be correct that oil prices are going up over the next year and still not make any money investing in USO unless oil prices go up by more than $14 per barrel. The first $14 is already baked into the futures market.
So what about UOY? Well, that's a bit of a different story but no less complicated. While UOY doesn't own futures contracts, it does use the front month contract to set the reference price for determining the NAV each night. At some point during the month (usually the 11th business day), UOY switches its reference price to the next month's contract. At that point, if the market is in a state of contango, like it is now, the NAV is going to jump up. So the shareholders of UOY will benefit from the price increase, correct? If only life were that simple!
In reality, everyone knows that the oil market is in a state of contango and UOY's NAV is going to rise over time so that's already baked into the price of UOY. In fact, UOY has been trading at a substantial premium to NAV for quite some time (and DOY has been trading at an equal discount in dollar terms). As of Tuesday night it was at a 40% premium and that premium has been as high as 73%, or more than $23 per barrel. So you are pretty close to being in the same situation that you would be with USO - the only way to profit from UOY is if oil prices rise by more than what the market expects.
There is another investment strategy here. Personally, I'm betting that the contango is going to go down. Consequently, I've purchased USO and offset it with DOY. If the contango goes down the discount on DOY should go down with it and I will profit. However, given the subtleties in these instruments, the outcome of this trade is far from certain.
Disclosure: Long USO and DOY
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This article has 30 comments:
Just curious, how does DBO fit into the mix here? It seems far less volatile than the other funds you mention even though it also invests in an index that is comprised of Light Sweet Crude futures?
DOY volume 100 shares
10.55AM New York time
The penny stocks have bigger volume than this 2 Oil ETN's.
On UOY bid/ask 13.00-13.31=2.5%
On DOY bid/ask 35.09-35.18=0.8%
With such liquidity and spread it is a suicide to trade it, if one believes Oil is a buy he can buy any Oil/Gas stock or for direct Crude Oil investment buy USO and for shorting sell USO.
2. The futures contract against which USO is calculated?
Would you care to comment on the ETN's, DXO and DTO, their structure and the ramifications of trading re. your article?
Also DTO double bear should down 60% because of its double about 80$, but why it still stay at the high level of 180 ? If there is "severe contango " ,should exist in both of the two funds, but "severe contango " can't explain the true reason for the funds tracking the crude oil index. Only one thing is there----That's "severe manipulation "rather than " severe contango" .
The canadian EFT hou.to and hod.to are more radiculous. For crude oil has risen from 32$ to 42$, so hou.to should be at around 11$ or more
but when crude oil up 1.2% it up 1.1%, crude down 1.6,it down 4.1%,so hou.to has fallen down over 30 times from 48$, and right now it is just equal to1.525$(5:1consolidat... or 7.63$ now, but oil is just down 147/41.5=3 times.
So contango can explain nothing, Just price manipulation.
Here I believe the market should be fair, just, open to every investor,and it should have a comparatively reasonable game rules.Or the market is robbing money from investor directly. So I call for an investigation from New York stock Exchange to get rid of the clear price manipulation.
If you are interested my opinion, you can compare the 4 ETF: USO bull and DTO bear; HOU.TO bull and HOD bear which is more distinct example for price manipulation rather than so called " contango ".Let up to complain to New York stock Exchange.
On Jan 29 10:47 AM SA Editor Jonathan Liss wrote:
> Gary,
>
> Just curious, how does DBO fit into the mix here? It seems far less
> volatile than the other funds you mention even though it also invests
> in an index that is comprised of Light Sweet Crude futures?
On Jan 29 10:59 AM ROLEX18K wrote:
> UOY volume 6,062 shares
> DOY volume 100 shares
>
> 10.55AM New York time
>
> The penny stocks have bigger volume than this 2 Oil ETN's.
> On UOY bid/ask 13.00-13.31=2.5%
> On DOY bid/ask 35.09-35.18=0.8%
> With such liquidity and spread it is a suicide to trade it, if one
> believes Oil is a buy he can buy any Oil/Gas stock or for direct
> Crude Oil investment buy USO and for shorting sell USO.
On Jan 29 01:41 PM allinstox wrote:
> Quick follow-up question - can you provide a link that details:
>
> 2. The futures contract against which USO is calculated?
www.investingminds.com...
On Jan 29 07:35 PM User 347374 wrote:
> Gary,
>
> Would you care to comment on the ETN's, DXO and DTO, their structure
> and the ramifications of trading re. your article?
>
>
On Jan 29 08:21 PM 777 wrote:
> Crude oil has risen from 32$ to 42$, that's 30% up altogether. But
> why USO still stay at the level of its lows ?I t should be around
> 40$.
> Also DTO double bear should down 60% because of its double about
> 80$, but why it still stay at the high level of 180 ? If there is
> "severe contango " ,should exist in both of the two funds, but "severe
> contango " can't explain the true reason for the funds tracking the
> crude oil index. Only one thing is there----That's "severe manipulation
> "rather than " severe contango" .
> The canadian EFT hou.to and hod.to are more radiculous. For crude
> oil has risen from 32$ to 42$, so hou.to should be at around 11$
> or more
> but when crude oil up 1.2% it up 1.1%, crude down 1.6,it down 4.1%,so
> hou.to has fallen down over 30 times from 48$, and right now it is
> just equal to1.525$(5:1consolidat... or 7.63$ now, but oil is just
> down 147/41.5=3 times.
> So contango can explain nothing, Just price manipulation.
> Here I believe the market should be fair, just, open to every investor,and
> it should have a comparatively reasonable game rules.Or the market
> is robbing money from investor directly. So I call for an investigation
> from New York stock Exchange to get rid of the clear price manipulation.
>
> If you are interested my opinion, you can compare the 4 ETF: USO
> bull and DTO bear; HOU.TO bull and HOD bear which is more distinct
> example for price manipulation rather than so called " contango ".Let
> up to complain to New York stock Exchange.
On Jan 30 01:38 AM DHH wrote:
> If it sucks to hold USO long term while there is contango, what should
> I buy if I want to bet that oil will head up in the long term?
because oil has risen up 30%.
The market should have its basic game rules,oil has risen but doule bull ETFs are falling sharply and double bear ETFs are rising strongly, who believe it reasonable without price manipulation? And investor do the market according what ?
To have a careul study, oil fall from 147$ to 42$,that's 3 times, but hou.to
from 48$ to 1.53$( which equals last close 7.63$ after 5:1 consolidation)that's over 30 times. 10 times for crude oil.
So complication can not explain the simplisity. Too much for the price control hurts every body. And IOP of the ETF ｉｓ ａ ｐｌｏｔ．
On Jan 29 10:35 PM Gary Lucido wrote:
> There is no manipulation. My article explains why USO doesn't track
> spot prices and the link directly above explains the issues with
> double long and short funds.
On Jan 30 08:38 AM tradetime wrote:
> Have you looked at USL, it's run by the same person / people as USO
> but invests in a 12 month range of contracts, if you compare over
> long term with USO on a percentage basis I think you'll find it performs
> much better in contango
On Jan 30 08:38 AM tradetime wrote:
> Have you looked at USL, it's run by the same person / people as USO
> but invests in a 12 month range of contracts, if you compare over
> long term with USO on a percentage basis I think you'll find it performs
> much better in contango
However, this is really stupid. If I want to invest in natural gas I'll buy UNG.
On Jan 30 02:04 PM secmaven wrote:
> A further complication with USO is that it is invested 25% in natural
> gas contracts.
img261.imageshack.us/i...
On Feb 01 04:10 AM User 348554 wrote:
> hey gary thanks alot . How does the oil index work - you explained
> uso but not oil.
Okay, I feel taken a bit here. My fault I guess.
What are my options if all I want to do is buy a stock/ETF/anything that purely tracks the price of a barrel of oil.
I am a bit upset that my money does not ride strictly on the barrel of crude oil price rising, but instead on how well it is predicted by the futures market. So, in this case, it looks like I hope they are ultra conservative, because if they are too aggressive or spot on, I make nothing, regardless of my play on increasing prices...
Is there anything out there that can just play off the price of a barrel of oil without this? Am I dreaming?
Another thing... I am into OIL right now.
Like you said it tracked right with USO until about a month ago. There seems to be ~4% delta there... Not sure how that works...
Any info on that would be great. Thanks.
On Feb 03 07:38 PM NewbieTom wrote:
> Gary,
> Another thing... I am into OIL right now.
>
> Like you said it tracked right with USO until about a month ago.
> There seems to be ~4% delta there... Not sure how that works...
>
>
> Any info on that would be great. Thanks.
Interesting article. Can you explain then why OIL and presumably also USO tracked the price of crude so closely during 2008? When crude went up ~50% from Jan 1 through the peak, OIL was within just a couple percentage points. The same goes for the fall from the peak to the trough. I understand the mechanics of what you are saying, but until the last few weeks, the divergence doesn't seem to be significant. What is the explanation for that? Thanks.