Why I'm Long ProShares Ultra Crude Oil ETF Despite Volatility

| About: ProShares Ultra (UCO)

As I went through college as an urban studies student, the author James Howard Kunstler greatly influenced my thinking. Kunstler became famous with the 1994 release of The Geography of Nowhere. The book chronicled the development of America as a predominantly suburban place, denigrating the lifestyle and all that it entails, particularly hideous architecture, social isolation, and car dependence. Kunstler made a living for a while writing about suburbia and traveling around the nation ripping it in front of any audience willing to listen, particularly impressionable college kids. While he still takes his shots at the suburbs, Kunstler has since moved on to a new target -- Peak Oil, which he contends will eradicate suburbia once and for all, while taking down many not-so-well-positioned cities with it. Kunstler muses about Peak Oil in one non-fiction book, The Long Emergency, and a two-part fictional series. Kunstler introduced me to the concept of Peak Oil.

Like many Peak Oil proponents, Kunstler comes off as obsessed with the idea. It got to a point, reading his weekly ramblings, where I seriously decided that he lost it. He either went nuts or, became so closely associated with the phenomenon that he desperately needs to be right. It's good for business and the ego. While I am not stockpiling ammo and moving the family out to a farm on cheap land in the middle of Wyoming, I remain convinced that oil prices will move with volatility throughout my lifetime and trend ultimately higher over the mid- to long-term, irrespective of who's "right" in the Peak Oil squabbles. I pay little attention to the spikes, such as the one experienced in the summer of 2008 and the one occurring now. It's all so predictable -- prices rise, people find other modes of transportation and cut out car trips, demand falls, prices retreat. Depending upon the extent and duration of the spike, it may or may not impact the domestic and global economies. This too shall pass. I think if you cut through the hype, you realize, without the attendant and unnecessary hysteria, that oil serves as a sound long-term investment.

How to Play Oil as an Investment

You can play the price of oil as a long-term investment, while generating consistent income, via the ProShares Ultra Dow Jones-UBS Crude Oil ETF (NYSEARCA:UCO). As a 2X ETF, UCO strives for daily results that are twice the return, on the up or downside, of the DJ-UBS Crude Oil Sub-Index. For instance, on February 23rd, the index closed up 3.12%; UCO increased by 7.74%.

Despite UCO's volatility, I am comfortable being long a considerable number of shares. Obviously when oil drops, UCO drops significantly. When oil rises, however, particularly on down days in the broader market, UCO serves as the perfect hedge. On the few days that stocks have bled red in 2011, UCO has helped make my portfolio's bottom line look much more impressive than it would have been otherwise. With 10 to 15 years or so before I will ever need the capital tied in UCO, I am quite confident in price appreciation that will meet or beat the broader stock market indices.

To generate income, I constantly write covered calls against my UCO shares. If you already own UCO, you find yourself in the best position if you got in earlier this year under $11. You can have sold March $13 calls on February 23rd for about $0.80, depending on your timing. The price of UCO would have to hit the call buyer's breakeven of $13.80 on or before the March 18 options expiration date for you to have your shares called away. In my case, it would not matter at all. My cost basis allows me to profit nicely on the stock as well as the collection of the call premium. I am confident that I can buy UCO shares once again on an inevitable dip in the price of the oil, if my shares got called away from me.

While I would might consider waiting for a pullback in UCO's share price, you could have taken advantage of the rise in UCO's call option premiums on February 23rd. Using a buy-write strategy, you could have sold one UCO March $14 call option for about $0.50, depending on your timing, for every 100 shares of the ETF you purchased. In this scenario, you run the risk of losing your shares if UCO hits $14.50 or higher between now and the March options expiration date. If you think oil gets pushed down from its present highs, you could get more aggressive and purchase the March $13 calls. You also have the option of looking at April or July expirations where premiums, of course, run higher, but a bull run in oil increases the chances that you'll have to give up your shares. But, again, you can move in and out of UCO with relative ease, given oil's propensity to gyrate with significant volatility.


In any investment scenario, it's best to ignore "sky is falling" hysteria (or ubridled euphoria) when you make your decisions. I like to keep myself as emotionally unattached as possible and stick to my short-term convictions and long-term guns. Things, including Peak Oil, have a way of working themselves out. Consider this anecdote. I worked in a bike shop during the summer of 2008. We could not keep $400 to $600 commuter bicycles in stock. As gas passed $4, I recall Southern Californians parking Porsches and BMWs in front of the shop, stepping inside, and asking for a bike they could use to ride to and from work several times a week. On the verge of an economic downturn, the bike shop never did better. People changed their behaviors and interest in alternatives -- fuels and modes of transit -- renewed. I prefer to watch the game unfold and attempt to calmly profit in the process.

Disclosure: I am long UCO.