The boom and bust in crude oil price in 2008 has increased retail investor interest in this asset class. Unlike professional traders, most retail investors do not trade oil futures but use ETFs which invest in oil futures contracts. The dominant ETF in this space is the US Oil Fund (NYSEARCA:USO), which invests its capital in the nearest month's WTI Futures contract. Another ETF which has gained recent investor attention is the US 12 Month Oil Fund (NYSEARCA:USL) which invests its capital in a basket of futures contracts stretching 12 months forward, with equal weight given to each month.
Over the past few months the contango in WTI Crude Futures has increased to a historically high level; the price of the contract for current month delivery is often $5-$10 less than the price for delivery a few months out. This is a result of the abundance of physical crude oil available for immediate delivery coupled with a reduction in demand for crude as refiners align their operations with lower economic activity.
Investors in the USO have been losing capital every time the fund rolls over its futures positions to the next month. This is because the next month's contract being bought trades at a significantly higher price than the current month contract being sold. The February roll cost investors almost $6/contract, a full 13.4% of their capital. The USL which rolls over only one twelfth of its contracts every month did not suffer such a drastic loss.
The availability of these ETFs also allows an investor to trade his or her expectation of the behavior of the crude-oil futures contract duration curve. If the investor expects the current contango situation to persist or worsen, he or she can sell the short end of the curve, by short selling the shares of the USO and buy the long end of the curve by buying shares of the USL. If the investor expects the contango to decrease as the current over head of supply reduces, he or she can go long the short end of the curve by buying the USO and go short the longer end of the curve by short selling the USL.
The managers of USO and USL, the United States Commodity Funds LLC, publish the dates at which they will roll over the futures contracts. The date for the next roll is March 6, 2009. These roll dates provide the precise point around which the pair trade is likely to make the biggest moves as illustrated by the action around January 6th and February 6th.
Disclosure: Vikram holds long and short positions in stocks, ETFs, futures and options related to the oil and energy.