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ETFs For When Oil Falls

by: Larry MacDonald June 12, 2008 | about stocks: DUG    
Larry MacDonald

Larry MacDonald

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I’m not convinced the price of crude oil will stay above $135 (U.S.) a barrel forever. Sure, there has been a secular rise in demand against scarce supplies but I think the price has also been inflated by some temporal factors, particularly the upswing in the global business cycle (now ebbing), rising investment demand (could be dampened by investigations into market manipulation/loopholes), and inflation hedging (central banks now shifting their focus to controlling inflation). A June 11 report from TD Economics provides further analysis supporting the bearish view.

As such, an interesting investment to consider is the Horizons BetaPro NYMEX Oil Bear Plus exchange-traded fund [ETF]. Listed on the Toronto Stock Exchange in Canada under the symbol HOD, it double shorts the price of oil, i.e. tracks “two times (200%) the inverse (opposite) of the daily performance of the NYMEX light sweet crude-oil futures contract for the next delivery month.” In the U.S., there is the UltraShort Oil & Gas ProShares ETF (DUG), which “returns 200% of the inverse of the performance of the Dow Jones U.S. Oil and Gas Index.”

The double-short oil ETFs let an investor short the oil sector without the hassle of an actual short trade on futures contracts or oil stocks (or buying put options). One can sit on the ETF position in a non-registered account or even a registered retirement account for as long as it takes, without the bother of margin calls or time decay.

That will come in handy. If oil spikes up more from here, one can just wait it out – although the paper loses could easily tally 20% to 30% given the volatility and leverage at work. Longer term, however, as the price of oil normalizes, the same volatility and leverage should erase the losses in short order and go on to provide some nice gains. Actually, as part of one’s strategy, it’s tempting to consider averaging down on the double-short oil ETFs if oil prices shoot up again from current levels. Disclosure: I own HOD (as of today).

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This article has 7 comments:

  •  
    Jun 12 10:02 PM
    And also for those of you who like standing in front of a freight train hoping that 2.4 seconds from now the laws of physics won’t apply, there’s DCR.

    “The investment seeks to track the negative price movement, before fees and expenses, of West Texas Intermediate crude oil.”
    Reply
  •  
    Jun 12 10:19 PM
    I should also add that if oil doesn’t fall below $120 by June 25, your entire investment in DCR is lost. If it does, you could make more than 300%. Do your own DD.
    Reply
  •  
    Jun 13 07:18 AM
    Banks are very negatively correlated with oil right now. KBE is -.9 with USO over the last year according to SSGA website. Why? Inflation. Oil is an inflation hedge and a drop in oil would by highly disinflationary. Lenders, like banks, loose money on inflation as borrowers make fixed payments in increasingly more worthless currency. So add KBE to your list of oil hedges.
    Reply
  •  
    Jun 13 10:09 AM
    I suckered into DUG when Bulls & Bears were pumping it at $41.41 and got screwed bigtime..
    Reply
  •  
    Jun 13 12:42 PM
    An alternative and appealing (to me) strategy is to go long natural gas incrementally as oil declines, given the historical trend of gas prices to replicate those of oil with a nine-month delay!
    Reply
  •  
    Jun 15 03:18 AM
    It's awfully late for DCR. I made 18% on it in late May/early June, but it's essentially a very short-term put on oil with very little time value and a big negative intrinsic.

    Glad to learn about HOD.TO. If you think current oil prices are out of line, that looks like the spot to put your money on.
    Reply
  •  
    Aug 08 11:09 PM
    Welcome to the HOD! I blogged about this vehicle in early June when the rate of change seemed too extreme to be sustainable. Nice to see this rise over $10 today (from a low of $6.30 on July 11th). The results so far have been solid and my planned exit will occur when oil hits $90 but I will reassess at $100.
    Reply
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