“Know what you personal” is an outdated adage when investing; however, it’s particularly vital when proudly owning investments that maintain futures contracts. Simply have a look at the most important oil ETF, the United States Oil Fund (USO). Many retail traders mistakenly imagine this can be a proxy for investing within the “spot” (cash) worth for oil.
Nevertheless, it isn’t, and by no means has been. The aim of the fund was to trace as intently as doable the entrance-month oil futures contract, not the spot value. True, the costs for spot oil and USO have been fairly shut — till the oil market imploded.
In idea, USO works in a quite simple method. Each month, about two weeks earlier than that “entrance month” contract expired, USO and related funds started shopping for the subsequent futures contract. Appears like a great way to wager on oil, proper? Besides, it isn’t — as a result of it owns futures contracts, not the spot value of oil.
Most futures markets are in “contango” — the value of contracts farther out in time are costlier than the sooner or “entrance-month” contracts attributable to the price of storing the commodity. That’s actually true of oil.
So each month, USO and different equally structured ETFs have to shut out their futures positions by shopping for the subsequent month’s contract, and since it’s virtually at all times the next value an investor over time — many months — will lose cash.
Because the quick-time period demand for oil has collapsed, the entrance-month contracts have collapsed, and the “unfold” between the entrance-month contracts and people farther out have gotten big: the June contract is at $13, the July is at $23. That implies that buyers — like USOs — that can finally rollover from June to the July contract are having to pay an enormous premium. Buyers, in these circumstances, are assured of losing cash. Plenty of it, particularly whether it is repeated for a number of months.