Oil ETF (USO): The drag

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Valentine Atkinson
5 years ago
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1 The U.S. Crude oil Fund (USO) tracks the price of crude closely* when the price of oil dropped 57%, USO also dropped 57%. However, since March, crude rose 39%, but USO only increased 27%. Why the discrepancy? * 1 month correlanon of daily price returns of of 9

2 June 2014 to March 2015, Crude and USO both decreased by 57% Since March 2015, Crude increased 39%, while USO increased only 27% 2 of 9

3 The impracncality of maintaining physical oil means the oil fund USO uses the futures contacts to track the price of crude. This is where the divergence between the USO ETF and spot crude occurs. 3 of 9

4 July $60.25 Aug $60.53 Sept $60.66 Oct $60.74 Nov $60.95 USO, since it uses futures to replicate crude spot, loses each month in the roll (i.e. each month, they sell the front- month and buy the back month). Since crude futures are currently in a state of contango (i.e. the back- month more expensive than the front- month), this creates a drag*. * contango is normal in most futures 4 of 9

5 Contango: Back month is more expensive than front month Backwarda7on Front month is more expensive than back month 5 of 9

6 A simplifica)on of how contango leads to drag follows: The fund sells 1000 contracts at $60.25 and nets $60,250. It then goes and buys the next month for $60.53 a contract but since the price is higher, it can only buy 995 contracts (instead of 1000). The price then rises 1 dollar. Since it holds only 995 contracts, instead of 1000 contracts, it makes only $995 instead of $1000. This is the drag. 6 of 9

7 Crude futures in contango leads to a drag in the USO likewise, a backwardated market leads to a lead in USO. For example, last year with crude in backwardanon, from July to September Crude dropped 10% while USO dropped 7%. 7 of 9

8 Secondary drag via the high expenses: USO also has a relanvely high expense rano of 72 basis points (0.72%) holders of USO pay this not in commissions but in holding the ETF over Nme. Currently this amounts to roughly $0.15 per share with USO at $20. 8 of 9

9 Takeaways: Crude is currently in a state of contango this makes USO underperform the spot market USO is a nice trading vehicle, but a poor long- term investment long- term alternanves include XLE and large oil companies 9 of 9

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