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Anomalous Behavior of the ProShares UltraShort Oil and Gas ETF

by: Phil Anthropy July 24, 2008 | about stocks: DUG / USO    

Phil Anthropy

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This is a revised article, correcting inaccuracies in an earlier version (removed), for which I apologize. During the past several months I have been trading ProShares UltraShort Oil and Gas (DUG). I have observed some interesting anomalies.

First, there have been periods where the price of oil has gone up, yet DUG -- the double inverse tracker of a collection of oil and gas exploration companies -- has gone up too; and vice versa. In other words, the oil and gas stock prices tracked by DUG sometimes encountered strong resistance or even fell although oil prices were increasing.

Some might wonder if this occasional lack of correlation is just a quirk of a double inverse fund which tracks a different, albeit related, index than oil. However, during this same period I have also traded United States Oil Fund (USO), which tracks oil prices somewhat linearly, and have observed a similar effect. There were periods where oil prices spiked up, yet USO stayed the same or dropped. I'm not talking here about huge moves, but since I was trading both stocks and options, small variations of a point or less were important to me. Perhaps there were times when oil bears shorted USO as oil prices rose, in anticipation of a later decline, so that there was no longer a positive correlation between USO and the increase in oil prices.

Another anomaly is that if one compares the price of DUG today with the price of oil, DUG is much higher than it was when oil was at this price before the spike up to over $140/bbl. This seems to reflect a less bullish sentiment (and lower prices) for oil stocks in DUG's holdings than was the case at the same oil price a few weeks ago, prior to the recent top. Therefore, overall, there appear to be more trading bets now that oil prices will fall than there were a month ago, if one compares the relative prices of DUG and oil now and back then.

In a separate but relevant matter, I have observed something that may indicate a large amount of program trading going on in DUG. I have also seen the same effect in other, actively traded stocks, but in DUG it is clearly evident.

The Level 2 real-time quotes I receive from TDAmeritrade are displayed as a dynamic bar graph. The horizontal axis has the current strike price always in the middle. The axis numbers move right or left as the strike price changes. The vertical bars to the left and right of center represent volume of the bid and ask at each price point away from the current strike.

Very often, I will see volume mysteriously appear and grow on both sides of the graph, far from the current strike. Then this volume will fade simultaneously from both sides, without ever seeming to strike a trade. Similar synchronicity takes place closer to the strike price, with supply and demand volume near the strike seeming to grow and fade together, yet without any trades going through (at least, the current volume cell on the display does not change).

This could be a quirk of the display software, although it is rather consistent. One possibility is that this is a "battle of the computers," with several programs trying to outwit each other in trading. If computer trades are triggered by mean or median price points (rather than current strike), based on the bid/asked prices and volumes in the "bid book," then transiently changing these prices and volumes might hack the opponent's algorithm and trigger a sub-optimal trading move. Another possibility is that these (often large) transient positions on both sides of the strike are temporary hedges against trades made elsewhere of another nature. However, they only last a few seconds, so this latter theory is less plausible.

These observations were available to me only because I have access to real time quotes and charts. Investors without such access are at a disadvantage. The volume charts in Yahoo! often seem to be smoothed out, and do not show the unusual volume spikes over short time periods that can drive a stock's price up or down significantly. Also, when watching a real-time chart unfolding, the speed and acceleration of rises and falls are visible. This is important trading information that static charts do not provide. For buy-and-hold investors, this level of detail may be superfluous, but for traders who think in terms of weeks, days or hours, it is helpful.

Disclosure: I trade DUG (long), DUG calls and USO puts.

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This article has 3 comments:

  •  
    Jul 24 02:52 PM
    It would seem that the trading in DUG by itself would affect the price of the ETF. An increase in buyers or sellers changes the price of DUG outside of the underlying index. The trend is with the index though.
    Reply
  •  
    Jul 24 05:29 PM
    Great article - been doing the same thing myself - sort of day trading or (month) trading DUG calls & puts. Recently things are not acting like they were a while back and I am confused as to what the hell is driving what ??? Is there some nefarious stuff going on - like the phantom stock short seller fiasco ?
    I thought I kinda knew what the hell I was doing !!!
    I'll be very interested in what you find out.
    Thanks again for the article.
    Reply
  •  
    Jul 24 06:46 PM
    DUG does not track oil itself. It is an index of oil and gas explorers and producers. They are related but definitely not the same.
    Reply
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