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USO / OIL ETCs and the Contango Effect


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USO / OIL ETCs and the Contango Effect

  #1 (permalink)
 Schebbi 
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Hi Everybody,

When I saw the Oil Price trading at new lows, I ran into an ETC (Wisdom Tree WTI unfortunatelly as a non US Citizen I cant buy the USO) and bought some Shares in the hope that oil Price will recover over the Long run and I can participate in higher prices.

Unfortunatelly, I wasnīt aware of the current Situation in the Underlying product which is obviously the Crude Oil Futures market. The Futurecontracts for the upcoming months trading at higher Prices than the current contract.


MAY 20 18.24

Jun 20 25.14

Jul 20 29.52

Aug 20 31.32

Sep 20 32.20

OCT 20 33.03

Nov 20 33.64

DEC 20 33.95 (Source: CME Group)

The Problem is, that the Oil Fund has to rollover their Position from month to month to represent the oil market. So for e.g. last week the United States Oil Fund (USO) had to sell the may 20 contract at around $20 and bought the Jun 20 contract at $25. So there was a spread of +$5. This Situation is called Contango.

So now here is the Question. Must the Jun 20 Contract now climb 25% (because $5 spread represents 25%) to just break even for the fund?
What happens when the jun 20 contract declines to $23 and the JUL will trade at $27 at the next rollover? And this happens over and over again? So at the end is it possible that in December the Crude Oil Price will be for example at $35 but the fund Price didnīt move or worst case declined in Price and I will have lost Money?


What would be a good alternative to participate in rising Oil Prices?


Thanks a lot for your help in Advance!

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 SMCJB 
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No but the Math isn't in your favor.

Let say you bought $10000 USO when May was $18.24. Your $10000 investment theoretically represents 549 barrels. Now USO rolls from May to June and sells their 549 barrels at $18.24 an buys 397 barrels at $25.14, So now you still one $10000 worth of oil but you own 28% less barrels.

This is what they call negative roll yield.

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 jokertrader 
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Unless you buy USO after it buys the June contracts which it already has and sell before it sells the June contracts/buy July contracts which based on what they usually do will start around May 13 or so????

FYI I am not in it or will be in it rather trade future flys for direction if I get the itch

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 jakobe 
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The USL ETF slightly solves this issue. They average their contract holdings into all 12 month contracts to mitigate the contango effect. The downside is the spot price doesn't move as sharply since the fund is composed of 12 month crude oil contracts. I'd recommend checking it out however.

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 suko 
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SMCJB View Post
No but the Math isn't in your favor.

Let say you bought $10000 USO when May was $18.24. Your $10000 investment theoretically represents 549 barrels. Now USO rolls from May to June and sells their 549 barrels at $18.24 an buys 397 barrels at $25.14, So now you still one $10000 worth of oil but you own 28% less barrels.

This is what they call negative roll yield.

@Schebbi

Essentially it's the same story with most of these franken product ETFs. With bonds that means TBT, with vol it's VXX.

If you spend some time to really understand this mechanism, then you can apply it elsewhere, and you can take advantage of it big time.

For example, you can use that roll yield as a tailwind to your directional assumption by shorting ETFs like TBT or VXX.


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jakobe View Post
The USL ETF slightly solves this issue. They average their contract holdings into all 12 month contracts to mitigate the contango effect. The downside is the spot price doesn't move as sharply since the fund is composed of 12 month crude oil contracts. I'd recommend checking it out however.

Agreed. Only slight F***Ed rather than completely F***ed. But being fair, if you don't access to futures USL is a better option than USO.

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 Schebbi 
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SMCJB View Post
Agreed. Only slight F***Ed rather than completely F***ed. But being fair, if you don't access to futures USL is a better option than USO.

In the picture you can see the result of the contango effect. It results in a huge tracking Error. The Chart shows the CL1! and the USO over time. It seems that USO is only good in tracking the downphases, but gives almost no reward in uphases.



I sold my ETC yesterday morning and invested in oil shares for example in Texas Pacific Land Trust (TPL). I think this is the better bet for the long run.

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  #8 (permalink)
 Schebbi 
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Just to make it complete. The USL seems really to be the better choice over the long run. It catches the upmoves much better.


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 SMCJB 
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Schebbi View Post
In the picture you can see the result of the contango effect. It results in a huge tracking Error. The Chart shows the CL1! and the USO over time. It seems that USO is only good in tracking the downphases, but gives almost no reward in uphases.



I sold my ETC yesterday morning and invested in oil shares for example in Texas Pacific Land Trust (TPL). I think this is the better bet for the long run.


Schebbi View Post
Just to make it complete. The USL seems really to be the better choice over the long run. It catches the upmoves much better.


Excellent illustration of negative roll yield in effect.

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