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Playing The Oil Trend With UWTI

The best way to cash in on a trend in crude oil is not by buying and selling the contracts but watching ETFs that track their prices. Over the past two years, these exchange traded funds have become very popular as oil prices plunged to sub-$30 levels. In a MarketWatch article , the VelocityShares 3x Long Crude Oil ETN (NYSEARCA: UWTI ) was cited as being the fifth most traded security by millennials. UWTI is hardly a tool for hedging against the risk of volatile oil prices. Instead, traders use the derivative as way to bet on different oil trends hoping to cash in on the accelerated payout it offers. This ETF generates a whopping 119 million shares of average volume despite year-to-date losses of over 38%. Its popularity trumps both the iPath S&P Crude Oil Total Return Index ETN ( OIL) and the United States Oil ETF ( USO), which average about 5 million and 51 million shares with YTD losses below 25%. There’s no doubt that UWTI provides traders the opportunity to cash out on an accurate projection of oil prices, but its high leverage and volatility can translate to large, sudden losses if a trend reverses. The best way to reduce risk created by unexpected, short-term fluctuations is to buy at the very bottom of the trend and hold until it tops off in the long run. With the market beginning to tame, investors should start to consider this trade before it’s too late. During the week ending March 12th, the price of West Texas Intermediate contracts rose from the low $30’s as investors finally saw production slow down. Baker Hughes reported earlier that week that rig counts fell to an all-time record low of 480 instigating pent up bullish sentiment. Recent evidence showing a decline in production has caused gains of just over 20% in the past month of trading sessions. While analysts are looking forward to a smaller supply in the future, traders can’t ignore the risks of the current fundamental situation which is still oversupplied by the extra oil still sitting idle in storage. Given how volatile oil trading has been over the past year and a half, skeptics have reason to doubt the rebound and may even see another plunge coming. That would mean complications for those waiting to bet on a bottom. I’m here to tell you not to worry. It’s time to bet on that bottom. Introducing the Deviation Moving Average first published and constantly updated on my blog here . This indicator is similar to a trend line with an adjustment that accounts for a constant deviation in price. The blue line follows WTI price, and is coupled with the orange line, a 50-day moving average plus the 10-day moving average of the actual price’s deviation from its 50-day moving average. With this enhancement, traders can track actual price movements against a deviation that the group has determined is acceptable. Because of intraday trading, the actual price will move either above or below its trend line. Crossover points show a reversal in short-term sentiment. The gap (length of time over or under the orange line) between each point is usually the same size and the variance (absolute value of the difference between the two lines) peaks at about the same height. This idea can be better visualized by the difference chart which is plotted over the past year. In the very volatile 2015, the gaps of smaller sentiment trends lasted just under a month with variance peaking at about $4.00. Using these observations, investors can predict where a small reversal may take place and where the momentum of those reversals are pushing the overall trend. Looking back at the first chart, one can see a curious trend that has developed over the past month. The actual price has not crossed over its deviation moving average line since February 12th, 2015. In fact, the variance has continued to stay constant despite reaching a difference of over $5.00. If the volatile trend of 2015 were to continue, WTI price would have started to fluctuate back downward about a week ago. So why has this not happened? Why has the gap been sustained? The chart shows a change in trend that occurred because of the shift in expectations from oil and gas investors. With the lower rig utilization and the hope of OPEC members freezing output, the buzz saw trend has softened with stability in the long-term price a reality. The new, smaller price channel that emerges might not reach above $50, but it will ease the uncertainty that has plagued oil corporations and oil exporting countries. Because UWTI is a derivative based on the price of oil, volatility there will begin to soften like it has in the WTI spot price trend. As the danger of a sudden plunge in price wanes, it will be safer to establish a long position consisting of UWTI or other energy ETFs. From there, one can ride a long-term trend upward without having to worry about a replay of the bearish tsunamis that drowned out the first month of 2016. Even if WTI were to crossover its deviation moving average in the near future, that point would be linger around the low- to mid-$30 range which is far from the bottoms established in January. With the deepest valley in the past, a smooth, upward climb for the price of oil will allow investors to cash out using the accelerated UWTI exchange traded fund. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Relief For Leveraged Oil ETFs

What a great contrast. While the otherwise surging U.S. markets ended August on a three-year low note (as a basis of monthly performance) and U.S. index futures are on a retreat, oil – the prolonged pain for investors – staged a rally. Oil has been trapped in a downward spiral since mid-2014. For over one year, there was hardly any relief for oil prices. Supply glut, be in the U.S. or in the other oil-rich nations, and global growth worries that resulted in demand concerns were responsible for the collapse in the oil prices. However, oil signaled a turnaround last Thursday, jumping over 10% and representing the biggest one-day rally in over six years. Gains kept rolling even on Friday and Monday, marking the largest three-day oil price gain in 25 years . This matters a lot for a commodity like oil, the price of which declined over 60% in the last one year (read: Oil Tumbles to Six-Year Low: ETF Tale of Two Sides ). In particular, the U.S. economy grew 3.7% in Q2, which beat the initial reading of 2.3% growth and 0.6% expansion recorded in the seasonally weak Q1. While this ruled out some demand-driven worries, the calm in the stock market turbulence in the latter part of last week and lower inventory crude stockpiles in the U.S. initiated this bright spell (read: Positive News Flow Sparks Off Rally in Oil ETFs ). On August 31, oil futures added over 8%. The optimism originated from the indication that the Organization of Petroleum Exporting Countries (OPEC) may cut back on production. Moreover, the U.S. government also reduced its estimate of domestic oil output. Domestic production in June was 9.3 million barrels a day, about 100,000 barrels short of the earlier prediction. Plus, the biggest synthetic crude oil manufacturer in Canada stopped production following a fire, which in turn boosted Canadian oil prices, per Reuters . A few analysts believe that these extraordinary gains in oil prices actually overprized the recent positive news. Compelling valuation is yet another reason for the bounce. So while positive news drove up all oil ETFs, fat gains were tied to the leveraged oil plays. Post oil price recovery, leveraged oil ETFs VelocityShares 3x Long Crude Oil ETN (NYSEARCA: UWTI ) with triple leverage and ProShares Ultra Bloomberg Crude Oil ETF (NYSEARCA: UCO ) with double exposure to the index added over 72% and 45%, respectively, in the last five trading sessions (as of August 31, 2015). Over the last three-day period (as of August 31, 2015), the funds were up 81% and 50%, respectively (read: 10-Minute Guide to 10 Most Popular Leveraged ETFs ). However, investors should note that leveraged ETFs are apt for short-term trading due to their extremely volatile nature. This is even truer for oil as this investing zone can be touted as one of the most risky plays. Global recovery is yet to be full-fledged with several economies tottering. So, demand-driven concerns are well in place. Now, recovery depends on when production cut takes place, if at all it happens. So, investors need to be vigilant while investing in the leveraged oil ETFs. Original post

The Real Danger Of Leveraged ETFs And ETNs

Summary A Seeking Alpha author highlights an unfortunate experience he had with a leveraged ETN. This article takes a closer look at the math – was the leveraged ETN to blame? The real dangers of using leverage ETFs and ETNs are presented. In a recent article entitled ” How I Got Burned By Leveraged ETNs “, Seeking Alpha author David Butler relates an unfortunate experience that he had with a 3x leveraged ETN, the VelocityShares 3x Long Crude Oil ETN (NYSEARCA: UWTI ). He writes about his investment: I bought in again at $3.64 believing the sky was the limit. Was it a dumb buy? Absolutely not. The mistake was not paying attention. Due to the big unrecoverable hits you can take on leveraged ETNs, you have to watch them closely and cut your losses quick if you start to lose. I was over confident. My past success had me thinking I couldn’t lose with this wonder security. Two weeks later, oil was in the beginning of its next downtrend…and I was kicking myself for losing a big portion of my previous gains. Did I take my medicine, cut my losses and sell? You all know the answer to that one. I waited. I thought “maybe oil will jump back up and I’ll get it all back”. Did it happen? You know the answer to that one too. UWTI’s chart says it all…. The author also presented an oft-quoted scenario, where the price of a security alternately increases and decreases by 10%, causing the corresponding 2X ETN to rapidly decay (original source ). In closing, David writes: Today, UWTI is trading at just around $1. Decay, combined with oil’s downward spiral killed me. Leveraged ETFs/ETNs Over the years, a number of Seeking Alpha authors have espoused on the pros and cons of leveraged ETFs or ETNs. At one extreme, Canary Cash gives reasons ” Why You Must Never Ever (Ever) Invest In A Leveraged ETN For Much Longer Than A Day “, one of which is the decay that occurs when the index increases and decreases successively. On the other hand, Dane Van Domelen has argued in an article entitled ” What The Numbers Say About Long-Term Investments In Leveraged ETFs ” that daily swings of plus- or minus-10% are exceptionally rare, and in most cases, the decay issue is much less serious than initially claimed. My personal portfolio also includes a number of income-generating, 2x leveraged funds, including the UBS ETRACS ETNs which I have written about extensively (see this article for a summary of the ETRACS line-up of 2x ETNs). By resetting monthly, these ETNs appear to partially mitigate the decay issue associated with daily-resetting funds. I have also studied the practical issues associated with harvesting this decay by shorting leveraged ETF/ETN pairs. Therefore, I was interested in further studying the reasons why David Butler’s investment in UWTI performed so poorly. Was it due to the inherent decay of leveraged ETFs/ETNs, or was it something else? At this juncture, I wish to emphasize that while much of this analysis focuses on David’s investment decision in UWTI and its associated consequences, this event could have happened to anyone, including myself. Furthermore, I do not intend to (nor am I qualified to) make a judgement on whether David’s investment at the time was “good” or “bad” – hindsight is always 20/20! The following is therefore intended to be a general analysis of the issues associated with an individual investing in any leveraged ETF/ETN. Comparing the 1x and 3x funds In his article, David writes that he bought UWTI at $3.64, but sold at around $1.00. As David did not provide the exact dates of his buying and selling, let’s assume that he bought on the last day that UWTI closed above $3.64, i.e. Jun 10th, and sold on the first day that UWTI closed below $1.00, i.e. Aug 19th. The following chart shows the price change for UWTI between those dates, together with the corresponding 1x fund, the iPath S&P GSCI Crude Oil Total Return ETN (NYSEARCA: OIL ). As expected, the 3x fund has done much worse than the 1x fund, but not three times as poorly – that would be impossible as it would take the price of the UWTI into negative territory. UWTI and OIL returned -74.6% and -39.0%, respectively, during this period. It is known that leveraged ETFs/ETNs suffer from beta decay or slippage when the underlying asset is volatile with no net change over a period of time. However, note that both UWTI and OIL declined nearly monotonically during the test period, with no notable rallies. Therefore, I would have to conclude that the beta decay or slippage of ETFs played only a small, if any, part in UWTI’s decline. The same exposure without leverage Let’s consider a hypothetical investor “Joe” who invests $10,000 into UWTI over the time period indicated above. Let’s also consider Joe’s twin brother, “Jack”, who has read about the dangers of using leveraged ETFs/ETNs and the decay associated with such funds. However, he still wants to have the same exposure to oil as Joe, so he instead decides to invest $30,000 into the corresponding 1x fund OIL. How have Joe and Jack fared over the time period indicated above? Since UWTI declined by -74.6%, Joe’s $10,000 investment has dwindled into $2,540, which represents a loss of $7,460. On the other hand, Jack’s $30,000 investment in oil declined by “only” -39.0% to $18,300, but because of his larger initial base, his nominal loss comes out to be $11,700, which is more than 50% that of Joe’s. In other words, investing $10,000 into a 3x fund rather than $30,000 into a 1x fund actually benefited Joe during oil’s decline, even though both brothers had the same apparent exposure to oil. The reason for this is quite simple. At the risk of stating the obvious, the maximum loss of a $10,000 investment is $10,000, while the maximum loss of a $30,000 investment is $30,000. Once OIL declined by more than 33% (turning Jack’s $30,000 into $20,000), there was no way that Joe could lose more money than Jack. In fact, if Jack had purchased OIL on 50% margin, a -39.0% fall in the fund will bring his percentage of equity to 18.0%, below the minimum maintenance requirement of most brokers, thus possibly triggering a margin call and leading to forced selling. The real danger of leveraged ETFs and ETNs The results of this exercise suggest that the real danger of leveraged ETFs and ETNs is not their inherent leverage, nor their associated decay. In my opinion, the first real danger of leveraged ETFs/ETNs is that investors “forget” that their investment is leveraged and neglect to position-size accordingly. This observation leads to the following advice: Only invest $10,000 in a 3x fund if you are entirely comfortable with investing $30,000 in the corresponding 1x fund . The second real danger of leveraged ETFs/ETNs is that any changes in price become amplified, leading to either of two pitfalls, the first of which is overconfidence. David Butler writes: I first bought the VelocityShares 3x Long Crude Oil ETN [UWTI] back in March for $2.24. Less than a month later I sold at $2.53. As the Exchange traded notes kept climbing I bought back in again at $2.82 and sold at $3.20. Suddenly, I was hooked on the volatility of oil ETFs and ETNs. David pocketed a cool 13% in less than a month on his first UWTI investment, while the underlying index might only have appreciated by around 4%. His second investment also returned 13%, although the time frame was not stated. A double-digit monthly return would undoubtedly be the envy of all of Wall Street, and it is understandable as to why an investor would become overconfident in such a situation. The second pitfall associated with amplified price changes is that when prices go south, the large proportional decrease in the leveraged fund might trigger panic in an investor, leading to selling at inopportune times. Notwithstanding the fact that such a panic sale might, in hindsight, have been the correct decision, it is a generally-accepted maxim that emotional behavior is best left out of stock-market decisions. Summary While a 74.6% loss in any investment is no fun, David Butler could possibly be comforted by the fact that had he invested three times of his UWTI investment amount into the corresponding 1x fund OIL, he would have lost over 50% as much money, despite having the same apparent exposure to oil. It is my opinion that the true dangers of leveraged ETFs/ETNs are not due to any structural issues associated with leverage or decay. Rather, I believe that the two main dangers of using leveraged products are both psychological . The first is the issue of position-sizing, and I believe that my advice from above bears repeating: Only invest $10,000 in a 3x fund if you are entirely comfortable with investing $30,000 in the corresponding 1x fund . only invest $10,000 in a 2x fund if you are entirely comfortable with investing $20,000 in the corresponding 1x fund . The second danger is that the amplified price movements of leveraged ETFs/ETNs can trigger either overconfidence (when prices go up) or panic (when prices go down) in the everyday investor. Finally, I should make the very obvious point that it is the choice of the underlying security that primarily determines a fund’s performance, and not whether it is 1x or 3x leveraged. Had Joe instead invested $10,000 into the VelocityShares 3x Inverse Crude ETN (NYSEARCA: DWTI ), the 3x leveraged short version of OIL, his investment would have ballooned to $31,670. DWTI data by YCharts I hope that this analysis was helpful for investors considering investing in leveraged ETFs or ETNs. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.