A Speculative Way to Play the Oil Bubble

They say the smart money is shorting oil. There is a lot of truth to that, but there is reasoning behind it. Much of the smart money people are talking about is long term investors, not many of the traders that are moving the commodity with "hot" money. What the smart money generally will do is make a small position at say $99 a barrel. When this is done, it is accomplished by adding to the position at each interval of resistance. This would generally be at $109, $119 and etc. This hedges their position and if the investor truly thought that oil would go below $100 a barrel long term, the short term move upward would be of little consequence.

If there is any one position that I would think you could add to in this situation, it would be to DCR. The reason is that this stock is moving exponentially with the price of oil. This ETF seems to have additional upside and downside risk as it was down over 12% today. The DCR is the inverse of UCR which tracks the price of crude as it is being priced in West Texas intermediate and light sweet crude. The UCR in comparison today was only down .36%.

The reason for the big change in valuation difference is somewhat complex, so I am going to try and make it as simple as possible. These two funds are interlocked through a trust. These up and down fund are best compared to total-return swaps, and both are backed by one trust. This trust is backed by treasury bills and short term securities that pays for the funds management fees. The funds compensate each other based on the Nymex light sweet crude oil futures contract.

The huge run up in oil prices have led to an interesting situation. Right now traders are betting that the down fund may run out of money. It only stands to reason that if the price of oil were to double in any direction, one fund would give all of its assets to the other.

The bylaws of the fund were set in such a way that if the price moved 85% a termination would start and at that date the trust would be paid out in the form of a dividend to the shareholders. When this happened the funds made notification that the termination would occur on June 25th. Since these funds are backed by a trust a certain amount of money will be paid out. Since the price of oil has went up so much there could be a huge reward for those betting on oil going down over the next month. There is little upside to the up fund as you can only double your money in this situation and that is why the DCR is moving at such a premium to their NAV.

The way to find the net asset value of UCR is by dividing the oil contract price by 3. To find the price of DCR you would subtract your UCR net asset value by $40 (as found in the Barron's article "This time an orderly march to the exits"). Remember, if the contract price is over $120 all of the money from the trust goes to shareholders of UCR.

This is the most interesting vehicle with respect to shorting oil, because if the shorts win, and there is a very fast decent in the price of oil, it may cause the contract price to move even faster. Very high level of risk, but as a short term play, may be worth the money. Especially if the increase in oil production from Saudi Arabia and the US stopping its additions to the strategic oil reserve cause a big move. This is also a big if, but the US could sell back some oil from the strategic oil reserve, since it has been buying oil during the increase of price. If this is done, it will crush the price of oil and move it back to a more true valuation.

Other ways to short oil would be through the USO and OIL, which track the price of oil consistently. Just short them like any other stock. You can short the UCR which has a much better valuation than DCR. You can short DIG or buy DUG which also gives you gas exposure.

Lastly, if you believe the price of gas will go up and the price of oil will cave, and then buy the refiners. TSO and VLO would be my recommendations, as historically TSO moves up faster with respect to a decrease in oil price. VLO is a little safer as it is not as volatile. My call twelve days ago on theupdown.com to buy the USO was up 5% as of yesterday, I would abandon this position.

Disclosure: Short

Comments

[Georealist]

On the surface all of this seems reasonable..until you dig a little. DCR would be inferior, in my opinion, to simply using DUG (ProShares Ultra Short Oil & Gas)...IF you are positing a drop in oil (and it's very likely if oil drops 20% nat gas will trail alongside) then why the halfway attempt to take advantage. It's alomost inconceivable that nat gas would continue to rise in a strongly corrective environment..since it stands roughly in relationship to oil as silver does to gold.
I suppose it would have been above and beyond to actually see your reasoning behind a possible near term decline (which is very likely) but that is hoping for a bit much.
By the by..there was no need to go into the lengthy nonsense about UCR...giving some insight into what the market move translates into and the REASON that has such a dramatic effect on refiners would be enough.

[MichaelFilloon(legmaker)]

georealist, very good points, but dcr is a trade. Buy in the morning around 1.15 and sell at 1.25. Been working for me. Have a great day and God Bless.

[RookieInvestor]

Legmaker, in simpler english. Is DCR a buy now, as oil has een rapidly declining now? I am a little confused as to what happens if by June 25th oil is not below $120 a barrel. Is any position I have in DCR then worthless if oil is not below the $120 a barrel mark by June 25th? If you can go into a little more detail in laymans I would appreciate it. Thank you.

[MichaelFilloon(legmaker)]

RookieInvest: Right now this etf needs to be shorted. I had thought the bubble would burst, but now that it appears this etf will end with oil above $120 it will go to zero. Thanks for the question.


On Jun 05 04:12 AM RookieInvest or wrote:

> Legmaker, in simpler english. Is DCR a buy now, as oil has een rapidly
> declining now? I am a little confused as to what happens if by June
> 25th oil is not below $120 a barrel. Is any position I have in DCR
> then worthless if oil is not below the $120 a barrel mark by June
> 25th? If you can go into a little more detail in laymans I would
> appreciate it. Thank you.

[MichaelFilloon(legmaker)]

At this point you are right Georealist, I think you can short DCR into the ground as this ETF will go to zero on the 24th.


On Jun 02 06:05 PM Georealist wrote:

> On the surface all of this seems reasonable..until you dig a little.
> DCR would be inferior, in my opinion, to simply using DUG (ProShares
> Ultra Short Oil & Gas)...IF you are positing a drop in oil (and it's
> very likely if oil drops 20% nat gas will trail alongside) then why
> the halfway attempt to take advantage. It's alomost inconceivable
> that nat gas would continue to rise in a strongly corrective environment..since
> it stands roughly in relationship to oil as silver does to gold.
>
> I suppose it would have been above and beyond to actually see your
> reasoning behind a possible near term decline (which is very likely)
> but that is hoping for a bit much.
> By the by..there was no need to go into the lengthy nonsense about
> UCR...giving some insight into what the market move translates into
> and the REASON that has such a dramatic effect on refiners would
> be enough.

[osgo]

Actually, all indicators show this ETF will go up quite nicely, especially as most think oil (at least this month) is headed down, you have the Saudi's Big Meeting on Monday to help lower the price and
market factors that are simply screaming for the price of crude to go down.

This is almost gambling...and very speculative...you could go BOHICA...but on the speculative side, if oil goes near $120, and u sell by the 25th...someone could make a lot of duckets.

I'm in...


On Jun 17 09:48 AM Michael Filloon (legmaker) wrote:

> At this point you are right Georealist, I think you can short DCR
> into the ground as this ETF will go to zero on the 24th.
>
>
> On Jun 02 06:05 PM Georealist wrote:
>
> > On the surface all of this seems reasonable..until you dig a little.

>
> > DCR would be inferior, in my opinion, to simply using DUG (ProShares

>
> > Ultra Short Oil & Gas)...IF you are positing a drop in oil (and
> it's
> > very likely if oil drops 20% nat gas will trail alongside) then
> why
> > the halfway attempt to take advantage. It's alomost inconceivable

>
> > that nat gas would continue to rise in a strongly corrective environment..since

>
> > it stands roughly in relationship to oil as silver does to gold.

>
> >
> > I suppose it would have been above and beyond to actually see your

>
> > reasoning behind a possible near term decline (which is very likely)

>
> > but that is hoping for a bit much.
> > By the by..there was no need to go into the lengthy nonsense about

>
> > UCR...giving some insight into what the market move translates
> into
> > and the REASON that has such a dramatic effect on refiners would

[User 213535]

I bought 2000 shares of DCR & it just keeps going down--even when oil goes up. My broker told me to sell. Anyone know what the payout might be?