How An ETF Can Drop 100% In A Day

September 17, 2015

Last week I wrote a blog in response to some questions readers had about the VelocityShares 3X Long Crude Oil ETN (UWTI), a popular product for trading the oil market with leverage. In that post titled "Can An ETF Go To Zero," I ultimately concluded that, "Technically, UWTI could fall extremely close to zero, though it would never reach that point."

My former colleague, ETF Analyst Boris Valentinov of FactSet, alerted me that there is one scenario that I overlooked.

"There is a way to actually go to zero, although very unlikely," he said. "If you have, say, a 3x-leveraged fund and the market goes down by 34 percent that day—the fund is done."

Boris is, of course, correct. If oil prices drop by more than 33.33 percent, UWTI will lose 100 percent of its value and holders will be completely wiped out.

UWTI Did Flirt With Disaster
As Boris also points out, it's never happened in the U.S., though it's certainly a possibility. A look at the data reveals that the biggest daily decline for UWTI so far was on Nov. 28, 2014, when the ETN lost 24.8 percent of its value. That came on a day that crude oil dropped about 10.2 percent, one of the bigger declines in recent history.

Yet despite the big moves in crude during the last year or so, the commodity hasn't seen anything near the extreme volatility that took place during times in the past. In fact, the drop in crude oil on Nov. 28, 2014, was only the 21st-largest in history.

The real monster moves came in the late '80s, early '90s and 2001, well before UWTI's launch in February 2012. Here are the five biggest single-day moves in front-month WTI crude oil futures:

Date % Change
1/17/1991 -33.00%
10/22/1990 -16.01%
7/22/1986 -15.43%
9/24/2001 -15.25%
3/24/1986 -12.98%

At the top of the list is the move in January 1991, when crude oil tumbled a whopping 33 percent in the midst of the Gulf War, after it became apparent that the conflict would not lead to significant supply disruptions as initially feared. On an intraday basis, oil prices fell as much as 34.06 percent.

So yes, however unlikely, it is possible for crude oil to fall that much and send UWTI to zero.

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