Oil has been making headlines over the past one-and-a-half years owing to huge swings in its prices. Oil prices took a U-turn after touching a 12-year low this February. In the last couple of months, oil prices demonstrated an encouraging rally on a strengthening global outlook and a weakening U.S. dollar.
The impressive gain came on the back of improving demand/supply dynamics, which helped in recouping confidence in investors regarding the oil market. The global surplus declined owing to production disruption from various corners of the world, especially Canada and Nigeria. On the other hand, global demand gained momentum and provided an additional boost.
But Why Didn't the Rally Last?
However, recently oil prices have again changed direction. United States Brent Oil Fund (NYSEARCA:BNO) - designed to track the daily changes in the spot price of Brent crude oil - lost over 6.9% in the last 10 trading sessions (as of July 14, 2016). On the other hand, United States Oil Fund (NYSEARCA:USO) − designed to track the movements of light, sweet crude oil (NYSE:WTI) - declined 7.7% in the last 10 trading sessions.
To start with, there was very little hope for a sustained recovery for this long-beleaguered commodity. Thus, as largely expected, oil prices have started dipping as investors look beyond short-term fundamentals such as supply disruptions in Canada and Nigeria.
Meanwhile, although the impact of Brexit on the oil industry is not yet clear, concerns over the effect the vote would have on U.K. and EU countries have justifiably surfaced. An analyst at Barclays has estimated that Brexit will reduce global oil demand by 100,000 barrels a day in both 2016 and 2017.
Apart from that, the rising greenback could also make oil expensive for those who are using other currencies. This would have an adverse impact on demand. Also, the squabble between Saudi Arabia and Iran related to output is keeping oil prices on tenterhooks.
How to Play?
Investors who expect additional weakness in the oil market can consider some of the bearish ETFs on the sector.
United States Short Oil Fund (NYSEARCA:DNO)
The fund has AUM of $10.9 million and average daily volume of 22,000 shares. The fund seeks to match the inverse performance of the spot price of light sweet crude oil WTI. It charges 60 bps in fees per year from investors and has gained about 6.8% in the trailing 10-day period.
DB Crude Oil Short ETN (NYSEARCA:SZO)
SZO is the least risky bet in the space providing -1x short exposure to WTI crude. The ETN tracks the Deutsche Bank Liquid Commodity Index-Oil for this purpose, while it also adds in the yield from short-term T-bills. However, the product is quite unpopular with an asset base of just $10.7 million and trades in low volumes of 2,000 shares, which might result in additional costs in the form of wide bid-ask spreads. Expenses come in at 75 basis points annually. The ETN gained 12.1% over the last 10 days.
ProShares UltraShort Bloomberg Crude Oil (NYSEARCA:SCO)
This fund seeks to deliver twice (2x or 200%) the inverse return of the daily performance of the Bloomberg WTI Crude Oil Subindex. It has attracted $173.3 million in its asset base and charges 95 bps in fees and expenses. Volume is solid as it exchanges nearly 742,000 shares in hand per day. The ETF returned about 13.3% over the last 10 days.
DB Crude Oil Double Short ETN (NYSEARCA:DTO)
This is also an ETN option providing 2x inverse exposure to the Deutsche Bank Liquid Commodity Index-Light Crude, which tracks the short performance of a basket of oil futures contracts. It has amassed $67.3 million in its asset base and trades in a daily volume of roughly 25,000 shares. The product charges 75 bps in fees per year from investors and is up 12.9% in the same time frame.
VelocityShares 3x Inverse Crude ETN (NYSEARCA:DWTI)
This product provides 3x or 300% exposure to the daily performance of the S&P GSCI Crude Oil Index Excess Return. The ETN is a bit pricey as it charges 1.35% in annual fees while average daily volume is good at over 2.4 million shares. It has amassed $285 million in its asset base and delivered returns of about 19.4% in the same period.
Investors should be careful while investing in leveraged exchange-traded notes (ETN), as these use derivatives instruments to amplify the returns of the underlying index. While this strategy is highly effective in the short term, their long-term performance could vary significantly from the actual performance of the underlying index due to a compounding effect.