Different Sort Of ETF Proposed To Short Crude Oil

June 26, 2009

Another ETF to short oil is being proposed, but this one has a twist.


The sponsor of the most popular oil exchange-traded fund is asking regulators for approval to offer a similar fund that shorts light sweet crude prices.

And while several already compete in that corner of the market, the United States Short Oil Fund would offer a different sort of take on inverse investing in crude.

The fund would trade on the NYSE Arca exchange and mimic many of the same characteristics of its sister U.S. Oil Fund (NYSE Arca: USO). When it launched in 2006, USO was the first oil-specific ETF to come to market. The creators of USO and the proposed short-positioned ETF is United States Commodity Funds LLC -- formerly Victoria Bay Asset Management.

As with USO, the new fund (referred to in the filing as USSO) will buy near-month futures contracts and then roll them over to the following months as they expire. But since it will attempt to short those positions, USSO plans to deliver inverse returns to the closest near-month contract prices. The exception to that rule is that when futures are within two weeks of expiration, pricing will be determined by the next month's contract.

The filing for an ETF that shorts oil comes on the heels of U.S. Commodity Funds' request with the Securities and Exchange Commission to offer a 12-month natural gas fund. (See related article here.)

Currently, four other exchange-traded products in the U.S. compete in the short oil arena.

Two are exchange-traded notes from PowerShares and Deutsche Bank. The Crude Oil Short ETN (NYSE: SZO) provides 1:1 inverse coverage of its underlying index. Meanwhile, the Crude Oil Double Short ETN (NYSE: DTO) does just what it name implies.

The other pair currently on the market comes from the ProShares lineup. Those are the Short Oil and Gas ProShares ETF (NYSE: DDG) and the UltraShort Oil and Gas ProShares (NYSE: DUG). The latter provides 200% inverse exposure to its index of oil and gas producers.

While each of these options might seem fairly closely related, a look at their underlying indexes and methodologies reveals some stark contrasts.

Perhaps the most obvious is that the ProShares ETFs don't stick to just oil producers. They track a Dow Jones index that replicates performances of companies such as Exxon Mobil (34% of holdings through March) and Chevron (13.62%). But it also includes in its top 10 Transocean, which operates drill ships and other vessels transporting oil and gas to suppliers.

From a purely portfolio-based view, the pair of PowerShares ETNs would appear closer as direct competitors to a new U.S. Short Oil Fund -- depending on how much inverse positioning is preferred. Both are based on Deutsche Bank indexes that track futures contracts. But SZO and DTO can also use three-month Treasuries to cushion volatility and smooth returns over time.

The proposed U.S. Short Oil Fund would operate more like a straight commodities pool. As such, USSO isn't likely to be registered under the Investment Company Act of 1940, as most open-end mutual funds and ETFs choose to do. That means, among other things, that the trust running USSO will probably need to re-apply every so often with the SEC for approval to offer more creation units.

It's a situation that another commodity pool in an exchange-traded structure run by U.S. Commodity Funds is facing. That has proved to be a hassle facing the U.S. Natural Gas ETF (NYSE: UNG) as its popularity has soared in recent months. (See related story here.)

Then again, going with an ETN with its counterparty risk during the current credit environment certainly poses its share of risks. But Deutsche Bank, issuers of the notes underlying SZO and DTO, is considered one of the strongest banks in Europe.

On Friday, its stock was raised to a "buy" rating by UBS analysts, who also bumped up their earnings projections for DB in 2009. Shares of DB have gained more than 50% so far this year.

You can read the USSO filing here.












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