Using an Inverse Oil ETF

There certainly has been no shortage of watching the oil markets over the last couple of years. From a high of $107.68 (West Texas Intermediate, light sweet futures) in June of 2014 oil had a stunning collapse down to $27.56 in January of 2016. That is a staggering loss of almost 75%. The drop led to the bankruptcy of MLPs and oil companies including Linn Energy and not to mention wreaking havoc on local banks that had lent money to the shale space. Deflation reared its ugly head throughout the entire commodity space, sending the broader Bloomberg CRB commodity index down to 159 in February of this year, a drop of almost 50% since June 2014. An inverse oil ETF could have mitigated much of that pain.

If you owned an inverse oil ETF over the aforementioned time frame, you would have seen the value of those shares (using the Short Oil & Gas ETF, DDG as the proxy) rise from $20.73 to $37.25, a return of 79% While no one is suggesting it’s easy to call the tops in markets but there were some clues suggesting a correction was coming, mainly the overly bullish sentiment indicators on crude oil. Likewise, happy American consumers were filling their gas tanks up for dirt cheap prices like $1.57 per gallon in Gulf areas like Florida.

Oil Inverse ETF

The best time to use inverse ETFs is after a long sustained rise in the underlying index or benchmark. Now may be an interesting time to look again at an inverse oil ETF. The price of West Texas Intermediate crude oil has vaulted from its $26.05 low to a high of $47.02 this week, a gain of 80.5%. There are a variety of different reasons you can point to for the bounce such as the Canadian wildfires (dubbed ‘The Beast’), improved economic data or just simple short covering. By some estimates, over one million barrels per day (up to 40% of total oil sand production) have gone offline as a consequence of the Alberta wildfires. Further, a positive oil forecast by the World Bank Group raised its price target for Black Gold to $41 per barrel from $37 per barrel amid weakening U.S. dollar and a receding of the oversupply of oil. The reality was that an incredibly lopsided 91% of ‘Large Speculators’ were bullish on the price of oil in March of 2014, according to the Daily Sentiment Index. When people are that bullish, they have already acted by buying oil so there’s really no buyers left. A few months later in June, the collapse was on.

No one knows for sure whether oil will retest the lows or not, but a move of that magnitude in just three months may be ripe for a pullback. The timing of the Saudi ARAMCO IPO, which could be the largest ever, also coincides with the conservative move to take some money off the table after oils recent price ascension. Plus, the U.S. dollar could strengthen again very easily and reaffirm its uptrend. If you still have significant energy exposure and have enjoyed a nice rebound over the last few months, you could hedge a portion of it against another sell-off in crude using an inverse oil ETF like DDG or DNO. DNO directly shorts the light, sweet crude futures whereas DDG inversely tracks the Dow Jones U.S. Oil and Gas Index.

Leveraged Oil Inverse ETF

For aggressive traders, there are a few leveraged funds that offer -2x or even -3x exposure to the price of oil. The UltraShort Oil & Gas ETF, DUG, is a double inverse oil ETF that performed quite well during the sell off from June 2014 through January 2016, appreciating almost 180%. A newer product, the Daily S&P 500 Oil & Gas Exploration and Production Bear Fund (DRIP) is a triple levered inverse oil ETF, that focuses on the more volatile E&P companies of the S&P Oil & Gas Exploration and Production Index. The fund didn’t start trading until June of 2015 so time will tell how this fund is able to perform in a sustained downturn in oil, but triple leveraged ETFs are certainly not for the faint of heart .