More Big Changes For Biggest Oil ETF

April 22, 2020

Trading premiums often develop in ETFs that have halted creations, because the arbitrage mechanism that usually keeps a fund's price in line with its underlying NAV can no longer work. Thus, as investors chase a limited amount of shares, they drive up the fund's trading price relative to its fair value.

It is unclear when the SEC will approve new shares for USO, or how long it will take the fund to reopen to creations afterward. For example, when the iShares Gold Trust (IAU) registered for an additional 300 million shares in 2016, the approval was granted and its creations restarted in five days.

But when the United States Natural Gas Fund LP (UNG) had to halt creations in 2009 for conditions similar to what's happening for USO now, it took two months for USCF to secure approval for new shares—and another two months to reopen the fund for creations.

USO Announces 1-for-8 Reverse Split

As if all this weren't enough excitement, this morning USO announced a 1-for-8 reverse share split that will become effective after the close of markets on April 28.

When an ETF reverse splits its shares, the number of outstanding shares falls while the price rises by some set factor. In a 1-for-8 split, the number of outstanding ETF shares would be reduced by eight, while its share price would be multiplied by eight. (Any shares that can't be evenly divisible by eight would be paid out in cash at fair value.)

Nothing about the fair value of the ETF or the securities inside its portfolio is impacted by a reverse share split. But issuers have used reverse share splits, especially lately, to prop up prices of ETFs that have fallen sharply. (Read: "What It Means When ETFs Reverse Split.")

Despite its massive inflows, USO's price has fallen precipitously, driven lower by the plummeting oil market that it tracks. More than a month ago, on March 18, USO closed below $5/share—its listing exchange's minimum allowable trading price—and hasn't risen above that threshold since.

Yesterday the ETF closed at $3.75, though the fund had fallen even lower in after-hours trading.

That said, USO isn't in danger of delisting just yet: The NYSE Arca's listing standard requires a fund to hold at $5/share or above for a majority of days over a six-month period; meaning, the exchange won't delist USO over one bad month or two.

Still, sub-$5/share isn't a trading price that USO's managers find desirable, and it might not take more than a few more weeks of trading there for the fund to bump up against that listing standard.

That’s why USO is doing the reverse share split. In fact, USO's prospectus gives its managers the discretion to adjust the price via share splits at any time "to maintain convenient trading ranges for investors."

What's Next For USO?

The situation for USO changes by the day, and investors should continue to trade USO with extreme caution (if at all).

USO's high premiums to NAV are likely to persist for some time, at least while creations are halted. It's also highly likely that bid/ask spreads for the fund will continue to widen; USO's 60-day average spread is now 0.17% and climbing higher.

In addition, the fund's impending reverse share split will void all open trade orders, such as limit orders, stop orders and so on. Options on USO will be impacted too. Therefore, after the reverse split occurs, investors should make sure to review their orders and replace any that have been canceled.

 

Contact Lara Crigger at [email protected]

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