HardAssetsInvestor

Written by Brad Zigler  |

February 10, 2009

The Boons And Banes Of Oil ETNs

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HardAssetsInvestor.com's managing editor explains the long and the short of some new inverse commodity products.

• The shape of the futures price curve
• Shopping for advantageous swaps
• The real-world effect of the market's contango

 

Way back in the Pleistocene Era (okay ... it was really just nine months ago), we asked why there weren't more inverse funds on offer for commodity investors ("Where Are The Short Funds?"). Our beef back then specifically focused on oil. Without short oil and distillate exposure available in exchange-traded funds or notes, we groused, there's no securities side alternative for futures crack spreads (examples of which are illustrated in "Energy Spreads Offer Leveraged Profits, Reduced Risk").

Well, the industry's put out some inverse products since then. Not a whole lot, mind you, but some. There are a lot more inverse products in registration, along with more leveraged commodity exposures.

So, are we happy now? Well, to the degree that there are more choices available for investors, yes. But we should point out that, performancewise, the newly introduced short notes and funds are not mirror images of their long counterparts. That is, you won't get the same results from buying an inverse product as you would by selling short its opposite number. The returns can sometimes be boons and sometimes banes, depending upon the shape of the futures price curve.

Oil-tracking exchange-traded products are prime examples. The returns obtained from purchasing inverse oil products have been largely influenced by recent shifts in the crude oil price structure from contango to backwardation and back.

Contango refers to the premium commanded by deferred futures over nearby contracts, as illustrated in "It's The Oil Carry, Not The Contango." When, for instance, March crude trades for $41 and April at $46, there's said to be a $5 contango. Contango markets are unloved by holders of long index funds and notes because of the negative yield – negative $5 in this case – that must be absorbed when a roll from an expiring nearby contract to a forward month is dictated. To roll a long position forward, March would have to be sold for $41 and April bought at $46.

Holders of inverse or short products, however, think a contango is swell. For good reason. To roll a short position forward, the nearby contract is purchased – to cover the existing short – and the forward contract sold to establish a new short position, the opposite of the swap done by long index investors. That yields a $5 gain or positive yield in this instance.

Last summer, a suite of inverse and leveraged oil notes were issued by Deutsche Bank just in time to catch the steep sell-off in crude prices. Each note tracks an oil subset of the Deutsche Bank Liquid Commodity Index (DBLCI). All are based upon the Optimum Yield version of DBLCI, which attempts to optimize roll returns by "shopping" for the most advantageous swap. Joining the PowerShares DB Crude Oil Long ETN (NYSE Arca: OLO) in the rollout were the PowerShares DB Crude Oil Short ETN (NYSE Arca: SZO), the PowerShares DB Crude Oil Double Long ETN (NYSE Arca: DXO) and the PowerShares DB Crude Oil Double Short ETN (NYSE Arca: DTO).