Market Overview

Leverage Cuts Both Ways For These Oil ETFs

Leverage Cuts Both Ways For These Oil ETFs

West Texas Intermediate futures scrapped together a modest gain Tuesday, but the benchmark U.S. oil contract still resides near 6 1/2-year lows. The United States Oil Fund (NYSE: USO) added nearly 2 percent Tuesday, a day after hitting an all-time, but USO closed near its lows of the day and is still doing little to inspire confidence.

USO, which tracks front month West Texas Intermediate contracts, is down more than 37 percent year-to-date and nearly 64 percent over the past 12 months. Using the standard definition of a security needing to fall 20 percent to be in a bear market, USO has experienced more than three bear markets in just a year.

As traders who have some experience with leveraged exchange traded products might suspect, things have been much, much worse for bullish leveraged oil ETFs and exchange traded notes (ETNs). Just look at the VelocityShares Daily 3x Long Crude ETN (NYSE: UWTI).

Related Link: Bank Of America Downgrades The Oil Sector

Crude Oil

UWTI, which attempts to deliver three times the daily performance of the S&P GSCI Crude Oil Index, closed Tuesday at $0.78, meaning a reverse split will likely being coming soon though no announcement has been made to that effect. Reverse splits for ETFs and ETNs that lose 84 percent in less than eight months, as UWTI has done, are not uncommon.

Then there is the case of the ProShares Ultra Bloomberg Crude Oil (NYSE: UCO). UCO tries to deliver double the daily performance of the Bloomberg WTI Crude Oil Subindex, an endeavor that is not going so well this year because UCO is down 65.6 percent.

UCO's Tuesday closing price shows the ETF flirting with $18, but that is very much the result of the ETF being reverse split on a 1-for-5 basis on May 20.

Another Problem

UCO and UWTI could face another problem. USO, the unleveraged oil fund that is overwhelmingly popular, has somehow attracted nearly $2 billion in assets this year. Now, there are concerns that oil ETFs like USO could become the tail that wags the dog of the oil market, sending spot prices lower if everyone heads for the exits at one time.

UCO and UWTI have inverse counterparts that are surging. Fortunately for some traders, they caught onto the VelocityShares Daily 3x Inverse Crude ETN (NYSE: DWTI), which has climbed more than 86 percent this year on its way to adding $111.7 million in new assets.

UCO has a bullish counterpart, the ProShares UltraShort Bloomberg Crude Oil (NYSE: SCO). SCO has returned 70.5 percent, but here is a vexing scenario: SCO has seen $18.9 million in outflows, while traders have allocated $845.3 million to UCO has that ETF has tumbled.

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