New Leveraged Oil Fund Replacement Coming

When Credit Suisse announced recently the de facto closure of the VelocityShares 3x and -3x oil funds, VelocityShares 3x Long Crude Oil ETN (UWTI) and VelocityShares 3X Inverse Crude Oil ETN (DWTI), the market greeted the news with a bit of a lament.

With well over $1 billion in the pair, the funds clearly had a place in investors’ (or at least speculators’) hearts.

As our Sumit Roy covered, you have some immediate alternatives, such as the ProShares Ultra Bloomberg Crude Oil (UCO), a 2x version, and two Direxion funds, the Direxion Daily Energy Bull 3x Shares (ERX) and the Direxion Daily Energy Bear 3x Shares (ERY), which provide exposure to energy stocks within the S&P 500.

But if you’re really craving the juice, US Commodity Funds has you covered. The issuer filed last night for a United States 3x Oil Fund. USCF already runs the most popular crude oil ETF in the land, the United States Oil Fund (USO), with over $3.4 billion in assets.

Here’s why the USCF filing is interesting …

There’s No SEC Risk

The leveraged and inverse fund industry is under intense scrutiny, and the SEC filed preliminary rulemaking earlier this year that could put significant restrictions on the amount of derivatives—and thus leverage—held in ’40 Act mutual funds and ETFs.

But like USO (and the competitive levered oil fund, the ProShares Ultra Bloomberg Crude Oil ETF, UCO), the new 3x fund won’t be regulated by the ’40 Act. Instead, it will be a commodity pool, which is regulated by the Commodity Futures Trading Commission.

So while 3x leveraged S&P 500 funds may face a tough 2017, if you stick to futures-based exposures, like commodities and volatility, the SEC is going to stay out of it.

Is there some risk the CFTC decides to start paying attention? It’s unlikely. The CFTC is down to three commissioners, which means that they are literally unable to talk to each other in the hallways because of “sunlight” rule provisions that prevent private meetings of a majority. The idea that a revamp of the very structure of a commodity pool could make it onto the regulatory agenda strikes me as unlikely.

It’s How Futures Traders Work

Issuers looking to provide levered and inverse exposure to other asset classes, like stocks or bonds, must jump through significant hoops to deliver on their promises. Generally, they’ll engage in daily-settled swap contracts with big banks to provide exposure, which in turn will go hedge their exposures with actual leveraged or short positions.

This is a somewhat-complex process that introduces some very small counterparty expense, and introduces a level of opacity to the process.

However, In traditional futures investing, leverage is the norm. If you want to buy one contract for West Texas Intermediate Crude, which represents exposure to 1,000 barrels of oil, you only need to have $2,900 in your account. That $2,900 gets you exposure to (right now) $49,000 of crude oil. ETFs using futures are a bit unique in that they generally have 100% collateralization—so for every $1 million in notional exposure to oil, they have $1 million sitting in cash to back it up.

For a commodity pool to use leverage, they simply have to enter more futures contracts, which they can continue to do until they run out of money to back those up. Theoretically, that means you could have more than 10x leverage in something like a crude oil fund.

It’s (Oddly) Only One Direction

Perhaps the most curious thing about this filing is that it’s only for a 3x daily leveraged fund—the equivalent of UWTI. On the one hand, this makes sense, since UWTI is the fund that had the most assets. But on the other hand, there’s really no difference between being a buyer and a seller of a futures contract. An inverse version of this new fund would look, essentially, exactly like this one, but for a few minus signs and a sentence or two of language.

US Commodity Funds already runs an 1x inverse crude oil fund using this structure, the United States Short Oil fund (DNO). That $10 million fund holds -224 futures contracts for January crude (meaning, it’s the seller of that contract), and holds cash and T-bills in collateral. To make the leveraged version, they’d simply have to sell more.

So why didn’t they file for the inverse version? My guess is they’re letting the leveraged version run as a stalking horse: The initial filing here is still missing many critical details (costs, tickers, etc.) and is filed for a paltry 1,000 shares. Expect that to change in subsequent filings, and, perhaps, to be joined by an inverse partner.

At the time of this writing, the author did not own any of the securities mentioned. You can reach Dave Nadig at [email protected].