The Toxic Oil ETFs: Bob Shiller Edition

At this minute spot oil is down 3%, while UCR is down more than 5% and DCR is up 9%

MacroShares Oil Up (UCR) and Oil Down (DCR) are “paired” ETFs, meaning that their sum is worth $40. UCR is supposed to track the price of oil on the upside and is worth one third the price of a barrel of oil. DCR is supposed to track the price of oil on the downside and is worth $40 minus DCR.

The WSJ on the MacroShares ETFs oil shares UCR and DCR:

The products were developed by Yale economist Robert Shiller to track crude-oil futures prices but have continued to trade at a wide “spread,” or difference, from their underlying shares.

Not a chance - the MacroShares are as perfectly priced as they can be.The MacroShares oil shares are not invested in oil, but in treasuries, and since they have a 20 year expected life, subject to not hitting certain “termination triggers”, they should trade and have always traded as a long term forward and not at the virtual phoney NAV computed by Mr. Shiller which is based on the nearby crude oil futures contract.I say “phoney” because the “underlying” doesn’t own crude oil.

When oil was in contango, UCR was at premium to spot and now that oil is in backwardation UCR is trading below spot as it should. We conclude that the “market” [should I say “wisdom of crowds”?] is smarter than a Yale economist in case we didn’t know.

But hang on, there is more fun ahead with the “termination triggers.” They come into play if the nearby [spot] crude oil futures closes above $111 or below $9 for 3 consecutive days.This means that strictly speaking the Up ETF is worth the forward price of oil plus the value of a K.O barrier option where the condition is “close at or above $111 for 3 consecutive days.”The probability of hitting the barrier is always below 50% until we hit it.

At $60, it doesn’t matter,the barrier option is pretty worthless but it gains value as we approach the barrier making the ETF much more volatile than spot crude oil. The first sentence of this post speaks for itself.

WSJ in action again:

In November, the MacroShares Oil Down product was trading at as much as an 80% premium to its net asset value, which ETF prices generally closely match, while the MacroShares Oil Up product traded at a 20% discount.

No, it wasn’t. See above - hope it’s clear.