How Contango Could Affect A Popular Oil ETF

To say the United States Oil Fund LP (ETF) USO, which tracks West Texas Intermediate crude oil futures, is a flawed product is accurate and fair. Over the past three years, USO is down 77.1 percent, but the exchange-traded product remains a favorite, on both sides of the oil trade, of professional traders.

Inflows to USO confirm as much. After adding nearly $3.1 billion in new assets last year, USO has seen year-to-date inflows of almost $900 million. USO's 2016 inflows put it just outside of the year's top 10 asset-gathering ETFs.

USO And Contango

Perhaps the greatest source of criticism against USO comes from the fact that the ETF is frequently in contango. As it pertains to USO, contango occurs when the West Texas intermediate futures currently held by the ETF trade at higher prices than the market expects that contract to trade at for the months ahead.

Related Link: Crude Oil Heading For Recent Low Of Move

“Oil traders should be aware that USO tracks front-month WTI future contracts and the underlying oil market is currently in a state of contango. Consequently, USO could experience a negative roll yield when rolling a maturing futures contract, or selling a contract that is about to expire in exchange for the next month contract,” according to ETF Trends.

WTI And Negative Yield Rolls

Speaking of negative yield roll, West Texas Intermediate futures are currently facing an epic negative yield roll.

“The widening in the 'contango' between the first and second futures contracts, or the March-April spread (CLH6-CLJ6), has exploded to ~8 percent in negative roll yield,” said Rareview Macro founder Neil Azous in a note out Wednesday evening.

As Azous noted, West Texas Intermediate's current level of contango is quadruple that of Brent crude, the global oil benchmark contract, on a percentage basis.

The problem for any trader, professional or retail, who is long USO is that instances of exaggerated West Texas Intermediate have previously given way to savage declines for that contract and USO.

“The extrapolation that the market will likely make into next week’s crude oil futures roll and options expiration is that the next leg lower in the barrel has started and this CLH6-CLJ6 spread can widen out dramatically as evidenced by the extreme widening to 25 percent back in the winter of 2008-2009 when the barrel finally bottomed out for that cycle,” added Azous.

Image Credit: Public Domain
Posted In: Brent CrudecrudeCrude OilETF TrendsNeil AzousOilRareview MacroWest Texas IntermediateWTINewsShort IdeasSpecialty ETFsCommoditiesIntraday UpdateMarketsTrading IdeasETFs

Ad Disclosure: The rate information is obtained by Bankrate from the listed institutions. Bankrate cannot guaranty the accuracy or availability of any rates shown above. Institutions may have different rates on their own websites than those posted on Bankrate.com. The listings that appear on this page are from companies from which this website receives compensation, which may impact how, where, and in what order products appear. This table does not include all companies or all available products.

All rates are subject to change without notice and may vary depending on location. These quotes are from banks, thrifts, and credit unions, some of whom have paid for a link to their own Web site where you can find additional information. Those with a paid link are our Advertisers. Those without a paid link are listings we obtain to improve the consumer shopping experience and are not Advertisers. To receive the Bankrate.com rate from an Advertiser, please identify yourself as a Bankrate customer. Bank and thrift deposits are insured by the Federal Deposit Insurance Corp. Credit union deposits are insured by the National Credit Union Administration.

Consumer Satisfaction: Bankrate attempts to verify the accuracy and availability of its Advertisers' terms through its quality assurance process and requires Advertisers to agree to our Terms and Conditions and to adhere to our Quality Control Program. If you believe that you have received an inaccurate quote or are otherwise not satisfied with the services provided to you by the institution you choose, please click here.

Rate collection and criteria: Click here for more information on rate collection and criteria.