Tag Archives: dwti

Still Believe In Goldman’s $20 Oil? Go Short With These ETFs

Oil has become the most perplexing commodity this year with wild swings in recent weeks. The latest and worst culprit is the China meltdown with global repercussions that is weighing heavily on demand. Further, ever-increasing production and a large supply glut are tempering its appeal across the board. As the Fed kept the rates on hold at its latest meeting on Thursday, oil price tumbled about 5% the next day. This is because the Fed’s decision of no rates hike led to further worries over the health of the global economy and will likely put more pressure on the price of oil. Notably, both U.S. and Brent crude have plunged about 15% in the year-to-date time frame with some forecasting a bigger drop in the days ahead. In particular, Goldman predicts that crude price could slide to $20 per barrel if production cuts fail to clear supply glut and new investments in the oil shale industry are not reduced (read: ” Oil ETFs Slide Again: More Pain in Store? “). Behind the Lower Forecast The demand and supply dynamics for oil is becoming worse by the day. This is especially true, as the Organization of Petroleum Exporting Countries (OPEC) has pumped out maximum oil in more than three years to maintain market share. Iran is looking to boost its production once the Tehran sanctions are lifted and inventories continue being built up. Additionally, oil production in the U.S. is hovering around its record level and crude stockpiles remain about 100 million barrels above the five-year seasonal average. However, the International Energy Agency (IEA) believes that the recent oil slump would force both the U.S. and other non-OPEC producers like Russia and the North Sea to cut their production sharply next year. It expects non-OPEC supply to reduce by 0.5 million barrels per day, the biggest decline in more than two decades, to 57.7 million barrels per day next year. Meanwhile, shale oil production in the U.S. will drop by 385,000 barrels per day. On the demand side, the agency expects global oil demand to climb to a five-year high of 1.7 million barrels per day this year and moderate to an increase of 1.4 million barrels per day next year (read: ” Positive News Flow Sparks Off Rally in Oil ETFs “). Though reduced output from non-OPEC and higher demand could check the global supply glut, the oil market will still remain oversupplied. As a result, Goldman lowered its 2016 price target for Brent and crude (WTI) to $49.50 per barrel and $45 per barrel from $62 and $57, respectively. Further, it also warned of crude hitting as low as $20 per barrel. How to Play? Given the bearish fundamentals, the appeal for oil will remain dull in the months ahead. This might compel investors to make a short play on the commodity, especially if they believe in Goldman. For those investors, while futures contracts or short-stock approaches are possibilities, there are a host of risk inverse oil ETF options that prevent investors from losing more than their initial investment. Below, we highlight some of these ETFs and the key differences between them: The United States Short Oil ETF (NYSEARCA: DNO ) This is an unpopular and liquid ETF in the oil space with an AUM of $24.7 million and average daily volume of 32,000 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 28.2% in the trailing 13-week period. PowerShares DB Crude Oil Short ETN (NYSEARCA: SZO ) This is an ETN option and arguably the least risky choice in this space as it provides inverse exposure to the WTI crude without any leverage. It tracks the Deutsche Bank Liquid Commodity Index – Oil – which measures the performance of the basket of oil futures contracts. The note is unpopular as depicted by an AUM of $28.5 million and average daily volume of nearly 35,000 shares a day. Expense ratio came in at 0.75%. The ETN gained 30.2% over the last 13-week period. ProShares UltraShort Bloomberg Crude Oil ETF (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 $152.7 million in its asset base and charges 95 bps in fees and expenses. Volume is solid as it exchanges nearly 1.7 million shares in hand per day. The ETF returned about 56% over the last 13 weeks (read: ” Oil Tumbles to Six-Year Low: ETF Tale of Two Sides “). PowerShares 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 $47.7 million in its asset base and trades in a moderate daily volume of roughly 103,000 shares. The product charges 75 bps in fees per year from investors and is up 28.3% in the same time frame. VelocityShares 3x Inverse Crude Oil 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 1.8 million shares. It has amassed $222.6 million in its asset base and delivered whopping returns of nearly 72.2% in the same period. Bottom Line As a caveat, investors should note that such products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing – when combined with leverage – may make these products deviate significantly from the expected long-term performance figures. Still, for those ETF investors who believe in Goldman and are bearish on oil, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is a friend” in this corner of the investing world. Original Post

The Real Danger Of Leveraged ETFs And ETNs

Summary A Seeking Alpha author highlights an unfortunate experience he had with a leveraged ETN. This article takes a closer look at the math – was the leveraged ETN to blame? The real dangers of using leverage ETFs and ETNs are presented. In a recent article entitled ” How I Got Burned By Leveraged ETNs “, Seeking Alpha author David Butler relates an unfortunate experience that he had with a 3x leveraged ETN, the VelocityShares 3x Long Crude Oil ETN (NYSEARCA: UWTI ). He writes about his investment: I bought in again at $3.64 believing the sky was the limit. Was it a dumb buy? Absolutely not. The mistake was not paying attention. Due to the big unrecoverable hits you can take on leveraged ETNs, you have to watch them closely and cut your losses quick if you start to lose. I was over confident. My past success had me thinking I couldn’t lose with this wonder security. Two weeks later, oil was in the beginning of its next downtrend…and I was kicking myself for losing a big portion of my previous gains. Did I take my medicine, cut my losses and sell? You all know the answer to that one. I waited. I thought “maybe oil will jump back up and I’ll get it all back”. Did it happen? You know the answer to that one too. UWTI’s chart says it all…. The author also presented an oft-quoted scenario, where the price of a security alternately increases and decreases by 10%, causing the corresponding 2X ETN to rapidly decay (original source ). In closing, David writes: Today, UWTI is trading at just around $1. Decay, combined with oil’s downward spiral killed me. Leveraged ETFs/ETNs Over the years, a number of Seeking Alpha authors have espoused on the pros and cons of leveraged ETFs or ETNs. At one extreme, Canary Cash gives reasons ” Why You Must Never Ever (Ever) Invest In A Leveraged ETN For Much Longer Than A Day “, one of which is the decay that occurs when the index increases and decreases successively. On the other hand, Dane Van Domelen has argued in an article entitled ” What The Numbers Say About Long-Term Investments In Leveraged ETFs ” that daily swings of plus- or minus-10% are exceptionally rare, and in most cases, the decay issue is much less serious than initially claimed. My personal portfolio also includes a number of income-generating, 2x leveraged funds, including the UBS ETRACS ETNs which I have written about extensively (see this article for a summary of the ETRACS line-up of 2x ETNs). By resetting monthly, these ETNs appear to partially mitigate the decay issue associated with daily-resetting funds. I have also studied the practical issues associated with harvesting this decay by shorting leveraged ETF/ETN pairs. Therefore, I was interested in further studying the reasons why David Butler’s investment in UWTI performed so poorly. Was it due to the inherent decay of leveraged ETFs/ETNs, or was it something else? At this juncture, I wish to emphasize that while much of this analysis focuses on David’s investment decision in UWTI and its associated consequences, this event could have happened to anyone, including myself. Furthermore, I do not intend to (nor am I qualified to) make a judgement on whether David’s investment at the time was “good” or “bad” – hindsight is always 20/20! The following is therefore intended to be a general analysis of the issues associated with an individual investing in any leveraged ETF/ETN. Comparing the 1x and 3x funds In his article, David writes that he bought UWTI at $3.64, but sold at around $1.00. As David did not provide the exact dates of his buying and selling, let’s assume that he bought on the last day that UWTI closed above $3.64, i.e. Jun 10th, and sold on the first day that UWTI closed below $1.00, i.e. Aug 19th. The following chart shows the price change for UWTI between those dates, together with the corresponding 1x fund, the iPath S&P GSCI Crude Oil Total Return ETN (NYSEARCA: OIL ). As expected, the 3x fund has done much worse than the 1x fund, but not three times as poorly – that would be impossible as it would take the price of the UWTI into negative territory. UWTI and OIL returned -74.6% and -39.0%, respectively, during this period. It is known that leveraged ETFs/ETNs suffer from beta decay or slippage when the underlying asset is volatile with no net change over a period of time. However, note that both UWTI and OIL declined nearly monotonically during the test period, with no notable rallies. Therefore, I would have to conclude that the beta decay or slippage of ETFs played only a small, if any, part in UWTI’s decline. The same exposure without leverage Let’s consider a hypothetical investor “Joe” who invests $10,000 into UWTI over the time period indicated above. Let’s also consider Joe’s twin brother, “Jack”, who has read about the dangers of using leveraged ETFs/ETNs and the decay associated with such funds. However, he still wants to have the same exposure to oil as Joe, so he instead decides to invest $30,000 into the corresponding 1x fund OIL. How have Joe and Jack fared over the time period indicated above? Since UWTI declined by -74.6%, Joe’s $10,000 investment has dwindled into $2,540, which represents a loss of $7,460. On the other hand, Jack’s $30,000 investment in oil declined by “only” -39.0% to $18,300, but because of his larger initial base, his nominal loss comes out to be $11,700, which is more than 50% that of Joe’s. In other words, investing $10,000 into a 3x fund rather than $30,000 into a 1x fund actually benefited Joe during oil’s decline, even though both brothers had the same apparent exposure to oil. The reason for this is quite simple. At the risk of stating the obvious, the maximum loss of a $10,000 investment is $10,000, while the maximum loss of a $30,000 investment is $30,000. Once OIL declined by more than 33% (turning Jack’s $30,000 into $20,000), there was no way that Joe could lose more money than Jack. In fact, if Jack had purchased OIL on 50% margin, a -39.0% fall in the fund will bring his percentage of equity to 18.0%, below the minimum maintenance requirement of most brokers, thus possibly triggering a margin call and leading to forced selling. The real danger of leveraged ETFs and ETNs The results of this exercise suggest that the real danger of leveraged ETFs and ETNs is not their inherent leverage, nor their associated decay. In my opinion, the first real danger of leveraged ETFs/ETNs is that investors “forget” that their investment is leveraged and neglect to position-size accordingly. This observation leads to the following advice: Only invest $10,000 in a 3x fund if you are entirely comfortable with investing $30,000 in the corresponding 1x fund . The second real danger of leveraged ETFs/ETNs is that any changes in price become amplified, leading to either of two pitfalls, the first of which is overconfidence. David Butler writes: I first bought the VelocityShares 3x Long Crude Oil ETN [UWTI] back in March for $2.24. Less than a month later I sold at $2.53. As the Exchange traded notes kept climbing I bought back in again at $2.82 and sold at $3.20. Suddenly, I was hooked on the volatility of oil ETFs and ETNs. David pocketed a cool 13% in less than a month on his first UWTI investment, while the underlying index might only have appreciated by around 4%. His second investment also returned 13%, although the time frame was not stated. A double-digit monthly return would undoubtedly be the envy of all of Wall Street, and it is understandable as to why an investor would become overconfident in such a situation. The second pitfall associated with amplified price changes is that when prices go south, the large proportional decrease in the leveraged fund might trigger panic in an investor, leading to selling at inopportune times. Notwithstanding the fact that such a panic sale might, in hindsight, have been the correct decision, it is a generally-accepted maxim that emotional behavior is best left out of stock-market decisions. Summary While a 74.6% loss in any investment is no fun, David Butler could possibly be comforted by the fact that had he invested three times of his UWTI investment amount into the corresponding 1x fund OIL, he would have lost over 50% as much money, despite having the same apparent exposure to oil. It is my opinion that the true dangers of leveraged ETFs/ETNs are not due to any structural issues associated with leverage or decay. Rather, I believe that the two main dangers of using leveraged products are both psychological . The first is the issue of position-sizing, and I believe that my advice from above bears repeating: Only invest $10,000 in a 3x fund if you are entirely comfortable with investing $30,000 in the corresponding 1x fund . only invest $10,000 in a 2x fund if you are entirely comfortable with investing $20,000 in the corresponding 1x fund . The second danger is that the amplified price movements of leveraged ETFs/ETNs can trigger either overconfidence (when prices go up) or panic (when prices go down) in the everyday investor. Finally, I should make the very obvious point that it is the choice of the underlying security that primarily determines a fund’s performance, and not whether it is 1x or 3x leveraged. Had Joe instead invested $10,000 into the VelocityShares 3x Inverse Crude ETN (NYSEARCA: DWTI ), the 3x leveraged short version of OIL, his investment would have ballooned to $31,670. DWTI data by YCharts I hope that this analysis was helpful for investors considering investing in leveraged ETFs or ETNs. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Trading Against Your Bias: How And Why

I initiated a short in crude oil back in July, and an astute reader sent me a good question. For many weeks/months, I had been operating with the assumption that crude oil was probably putting in a long-term bottom based on the action back in March/April of 2015; his question was how and why did I take a short against that bias. It’s a good and instructive question, so I thought I’d share the answer with you here. One of the advantages of writing about financial markets and publishing that work every day is that I have a record of what I was thinking and saying at any point in time. As I’ve written many times, I think journaling is one of the key skills of professional trading – this is a form of that. Let me set the background with some charts from a few months ago. A good place to start is in the aftermath of the 2014-2015 sell-off in crude oil. The market bounced in February 2015, set up another short attempt that more or less ran out of steam around the previous lows, and then rallied strongly off those March lows. In early April, I began to work with the idea that crude may have just put in a bottom. A chart says it better: (click to enlarge) Back in April, the case for a bottom in crude oil. Over the next few months, this thesis appeared to be playing out, but it’s important to remember that a bottom is a process. We don’t (usually) identify the absolute extreme of a move and then expect the market never to return. No, it’s far more likely that the market will go flat a while (check), and perhaps even re-test the previous extreme. This is normal, and it may even be those retests that really hammer the bottom in place. It’s easy to imagine hordes of traders thinking that crude oil is going to $20, entering short on a breakdown, and then watching in dismay as the market explodes to new highs after barely taking out the previous lows. A market will do whatever it can, at any time, to hurt the largest number of traders This, in fact, is nearly a principle of market behavior: A market will do whatever it can, at any time, to hurt the largest number of traders. That’s not just cynicism, I think it’s a legitimate consequence of the true nature of the market . Now, we certainly don’t want to be one of those gullible traders who gets tricked into shorting at exactly the wrong time, do we? So what do we do when the market gives us a nice, fat pitch right over the center of the plate, like this? A nice setup for a short, but what about the higher time frame conflict? And just to complete (or, perhaps, to further complicate) the picture, here’s the weekly chart from the same day: Thoughts on that higher time frame. So, just to clarify the situation here, in some bullet points, are the most important elements of market structure at the time we might have been thinking about a short entry: Within the past year, this market had a historic decline. Many people are inclined to think “Too far, too fast,” and that the move will reverse. On the other hand, maybe something fundamentally has changed. At the very least, we need to be aware that these might not be “normal” market conditions. After that historic decline, oil put in what looked like the first part of a bottom: A retest of lows, strong upside momentum off those lows, and then, daily consolidation patterns breaking to the upside. Following that step, the market went flat and dull, perhaps setting up a breakout trade. That breakout was to the downside, and a clear daily bear flag formed after the breakdown. Taking a short could mean going against the longer-term bottom (if it is forming), so what do we do? Many traders end up paralyzed with multiple time frames, as it’s easy to get overwhelmed with information. This is obviously a mistake, but there are also gurus who oversimplify the subject, saying, for instance, to only take a trade when it lines up with the higher-time frame trend. Though this idea is elegant and appealing, it falls short on several counts. For one, the best trades often come at turns, and if you wait to see an established trend, you’ll miss those trades; and even more importantly, the moving average-based trend indicators people use do not work like they think. (In fact, when a moving average trend indicator tells you a market is in an uptrend, at least for stocks, the stock is more likely go down !) Managing the conflicts How do we resolve all of this? I think this is a question that every trader must answer as part of his or her own trading plan. The one thing you probably cannot do is take each case as a new thing and try to make up rules for each situation. It’s far better to have a plan, and to then to follow that plan with discipline. For me, the answer is that a trade is just a trade. I have never been able to prove that having multiple time frames aligned actually increases the probability of those trades. (Though, those examples do sell books!) The way I think about it, if I have a higher-time frame trade that points up and a lower-time frame trade that points down, one of those trades will likely fail. I don’t know which, and I can’t know which in advance. If I knew the higher-time frame trend was more likely to work, I’d just trade that one, but in all intellectual honesty, I don’t know that. No one does. It’s possible that higher-time frame trend will fail because of the meltdown on the lower time frame, and if I’m positioned with that lower time frame, then I will be happy. It’s also possible I will get my first profit target even if the higher-time frame pattern “wins”, so I may be able to make money on both sides of the trade. Perhaps I want to skip the lower-time frame trade and just look for a higher-time frame trade around the previous low – that’s also a viable strategy. What matters is that I know what I will do in advance, and that I am honest about the limitations and constraints. We can only work within the laws of probability, and there are certainly limits to what can be known. It’s not a question of my competence as a trader, but of molding the methodology to fit the realities of the market. A trade is just a trade – avoid complications, and simplify.