Best instruments for shorting oil?

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dothemontecarlo
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Best instruments for shorting oil?

Post by dothemontecarlo »

I know it isn't bogleheady to ask this, but w/ oil at $138/barrel -- and with more and more people talking about $200/barrel or $10,000/barrel, etc. and wanting to hang all the "damn" speculators -- I'm very tempted to speculate myself, by shorting oil.

The question is, what ETF or ETN provides the best mechanism for shorting it?

There was a paired oil up/oil down instrument recently that just didn't work right (didn't follow their benchmarks), so recommendations for a more functional ETF/ETN would be appreciated.

And if I speculate against oil, that would make me a political hero, right? If it's bad to speculate on oil rising, it must be good to speculate on its fall. :roll:
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bob90245
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Post by bob90245 »

USO if you want an ETF.
OIL if you want an ETN.

Don't know if one is better than the other for your purposes.
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Re: Best instruments for shorting oil?

Post by SoonerSunDevil »

dothemontecarlo wrote:I know it isn't bogleheady to ask this, but w/ oil at $138/barrel -- and with more and more people talking about $200/barrel or $10,000/barrel, etc. and wanting to hang all the "damn" speculators -- I'm very tempted to speculate myself, by shorting oil.
If oil hits $150/barrel, I'm going to buy put options on USO. If oil hits $200/barrel, I'm going to take out student loans and/or 0% credit card offers to buy even more put options on USO. This bubble is going to burst... eventually.
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Post by bob90245 »

I should add the usual cautions which I'm sure you've heard before. Like, markets can remain irrational longer than you can remain solvent. Also, I read that today's price spike was due in part to traders who were short going back and buying to cover their positions. So it's a double-edged sword.
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Post by dothemontecarlo »

bob90245 wrote:USO if you want an ETF.
OIL if you want an ETN.

Don't know if one is better than the other for your purposes.
I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
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Post by dothemontecarlo »

bob90245 wrote:I should add the usual cautions which I'm sure you've heard before. Like, markets can remain irrational longer than you can remain solvent. Also, I read that today's price spike was due in part to traders who were short going back and buying to cover their positions. So it's a double-edged sword.
Agreed. But I think it makes sense to look at investments, whether long or short, through the prism of expected returns and volatilities. If going short on something has a positive expected return over a fairly long time frame (pretty rare, but it can happen), then I think it is something to consider. Of course, that's a pretty subjective call. To me, oil is looking like Nasdaq 5000, er, maybe Nasdaq 4000, maybe Nasdaq 3000 (who knows?). Well, expensive and overvalued, anyway. (But can I stomach the possible ride up to 5000 before it (hopefully) collapses back to 1500? Hmm...)
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Post by indexfundfan »

dothemontecarlo wrote:
bob90245 wrote:USO if you want an ETF.
OIL if you want an ETN.

Don't know if one is better than the other for your purposes.
I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
DCR

http://www.macroshares.com/public/macro/macrohome.aspx

Note: With the recent high oil prices, this security has dropped to below one buck.
My signature has been deleted.
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Post by bob90245 »

dothemontecarlo wrote:To me, oil is looking like Nasdaq 5000, er, maybe Nasdaq 4000, maybe Nasdaq 3000 (who knows?). Well, expensive and overvalued, anyway. (But can I stomach the possible ride up to 5000 before it (hopefully) collapses back to 1500? Hmm...)
Unfortunately, you're at a disadvantage. The Nasdaq, at least, had the P/E ratio printed in the financial pages telling you to what degree the market had become overvalued. As far as I know, there is no similar metric for oil.

In a different vein, Valuethinker raised the possibilty on another thread that oil has been too low all along. So today's prices, for all we know, is finally reaching "fair value".
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Ariel
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Post by Ariel »

DCR is a tricky one. It's paired with UCR as part of a trust. Despite it's cheap price, DCR may be selling at a premium over its NAV. http://www.etfconnect.com/select/fundpa ... FID=170372
I think it's due to be liquidated since it was essentially part of a "double or nothing" inverse fund with UCR. Not sure of details but be careful with it!

DUG and DIG are another pair, ultra short and ultra long but based on oil and gas companies, not the commodity itself. Energy stocks were actually down sharply today -- XLE lost almost 2%.

Another strategy to consider might be to go _long_ with some sector that you think will benefit from dropping oil prices ... say, airlines or trucking companies.

Just some ideas. No doubt it's a dangerous bet in any case!

EDIT: Here's the announcement that DCR and UCR are being closed out as the "trigger" price was reached ... way back when oil was cheap at "only" $111.
http://www.macroshares.com/public/commo ... 966e30c07c
Do what you will, the capital is at hazard ... - Justice Samuel Putnam (1830), as quoted by John Bogle (1994)
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Post by Russell »

dothemontecarlo wrote:
bob90245 wrote:USO if you want an ETF.
OIL if you want an ETN.

Don't know if one is better than the other for your purposes.
I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
Buying a nice deep in the money put option works as a leveraged short... and is generally much nicer than the inverse ETFs... and you should be able to do that in an IRA (if you are truly so inclined)....

The options on USO appear to be reasonably liquid. :D Good luck!!!!
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Post by manatee »

The big oil companies such as XOM, BP, etc would be good places to start. You don't need to worry about Exxon having some windfall from a new oil field since they aren't taking on any. Therefore their price should closely correlate oil prices.
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Post by docneil88 »

Hi dothemontecarlo and SoonerSunDevil,

I'm interested to know what measures of valuation or other statistics you looked at before deciding that oil is vulnerable to a large price drop right here.

Thanks. Best, Neil
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Post by dumbmoney »

A long bet on oil at least has the virtue of being negatively correlated with other investments. I don't see any advantage in shorting oil...seems like reckless gambling.
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Post by Sidney »

Have you considered buying used F-250s?
I always wanted to be a procrastinator.
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Post by Valuethinker »

bob90245 wrote:
In a different vein, Valuethinker raised the possibilty on another thread that oil has been too low all along. So today's prices, for all we know, is finally reaching "fair value".
It's difficult, looking at the last few weeks move, to believe that this is 'rational' oil pricing. There's been no sudden change in look or outlook for oil consumption or demand that would justify it.

The long run marginal cost of new oil production has risen sharply, but is probably between $70 and $90/bl. Oil prices should fall towards that level.

And yet.... that we know of, there are no big oil projects to come onstream (Brasil being the obvious, but that is years and years away).

What I suspect will happen is world demand will slow down faster than we currently expect eg by the US airline industry essentially going offline (exaggeration). This will be accompanied by new marginal production coming onstream (stripper wells etc) and substitution where possible (eg in Pakistan, they heavily use natural gas to fuel vehicles).

Real interest rates are currently negative, and this removes the penalty for holding stockpiles, and the penalty on overinvesting. As and when interest rates again become positive (one way this would be achieved would be by certain countries appreciating their currencies ie monetary tightening via exchange rates) I expect the world growth in demand for oil to slow.

It's worth remembering that the new demand almost all comes from countries that charge less than world price for oil to their citizens.

Malaysia for example was looking at oil price subsidies amounting to 7% of GDP, and India pays subsidies already 3% of GDP. Malaysia has now announced (?60%) oil price increases, but Malaysian gasoline will still be fairly cheap.
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Post by zhiwiller »

dothemontecarlo wrote:I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
There's a reason you aren't allowed to...
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Post by financialguy »

You could always put a little money into equities that stand to do well if oil falls -- e.g., plastics companies and airlines.
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Post by stratton »

financialguy wrote:You could always put a little money into equities that stand to do well if oil falls -- e.g., plastics companies and airlines.
I'd assert *any* equity will do well if the price of oil falls.

Paul
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Post by xerty24 »

Macroshares will be issuing a replacement pair of securities for UCR/DCR once these wind down this month or next. In the meanwhile, buying DCR is essentially an oil put option struck at ~$120 so if that's what you want feel free to buy it.

If you had a self-directed IRA custodian you could even sell fully collateralized crude futures directly, but that would require a setup few people have in place.
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Post by Xyrus »

There's a few:

DCR- but that's going away soon though it may be replaced.
DUG- Double short oil and gas.

Then there are a couple which short general commodities (including oil):

DDP- Commodity short
DEE- Commodity double short

Risky business. GL.

~X~
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Post by schwarm »

Valuethinker wrote:
It's worth remembering that the new demand almost all comes from countries that charge less than world price for oil to their citizens.

Malaysia for example was looking at oil price subsidies amounting to 7% of GDP, and India pays subsidies already 3% of GDP. Malaysia has now announced (?60%) oil price increases, but Malaysian gasoline will still be fairly cheap.
Probably most subsidies will go away in oil importing countries. Oil exporting countries are a different matter. The **** *** crowd is now most concerned about the availability of oil exports going forward.
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Post by dothemontecarlo »

Russell wrote:
dothemontecarlo wrote:
bob90245 wrote:USO if you want an ETF.
OIL if you want an ETN.

Don't know if one is better than the other for your purposes.
I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
Buying a nice deep in the money put option works as a leveraged short... and is generally much nicer than the inverse ETFs... and you should be able to do that in an IRA (if you are truly so inclined)....

The options on USO appear to be reasonably liquid. :D Good luck!!!!
I've never dabbled in options before. That's principally because every time I look at the bid-ask spreads, I'm deterred. See, e.g., USO options data. 5% spreads are not uncommon. Looks the like the middleman gets a pretty big piece of the action (his reward, my risk). Given how thin equity risk premiums tend to be, 5% for the middleman is way too much for me.

The second reason is that I don't know how to value/evaluate options. Looking at the USO options, for example, you have to pay $23 for a put option on oil with a $108 strike price that expires in just over 18 months. That means for me to profit, oil would need to drop to $80/barrel or less on that option within the next 18 months. That doesn't strike me as a very appealing bet (but of course I'm risking less than I would by selling oil short).

I guess I would need to learn the Black-Scholes model and start doing the calculations. Without knowing the model but just looking at the prices above, my math intuition tells me that the steep prices of these deep-out-of-the-money oil put options reflect a high "implied volatility." (Otherwise, it would be idiotic to buy them).

I might try to learn the Black-Scholes model someday, but only if those bid-ask spreads get close enough to 0 (e.g., 1% or less) to tempt me.
Last edited by dothemontecarlo on Sat Jun 07, 2008 11:43 pm, edited 1 time in total.
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Post by dothemontecarlo »

zhiwiller wrote:
dothemontecarlo wrote:I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
There's a reason you aren't allowed to...
Please, anyone, enlighten me. Why not?
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Post by dothemontecarlo »

manatee wrote:The big oil companies such as XOM, BP, etc would be good places to start. You don't need to worry about Exxon having some windfall from a new oil field since they aren't taking on any. Therefore their price should closely correlate oil prices.
Not a close proxy at all, IMHO. First, these same companies are priced at pretty low P/E ratios, because (I suppose) the market is expecting those oil prices & accompanying profits to go back down. Second, those companies are probably selling an awful lot of futures in order to lock in high profits even if prices do go down. If I want to sell oil short, I basically want to do the same thing the oil companies are doing -- selling oil futures. If so, selling the oil companies short isn't going to accompish the same goal.
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Post by grumel »

dothemontecarlo wrote:
zhiwiller wrote:
dothemontecarlo wrote:I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
There's a reason you aren't allowed to...
Please, anyone, enlighten me. Why not?
Because some stupid lawmaker thought that iras were for retirment savings not for gambling.
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Post by jpsfranks »

grumel wrote:
dothemontecarlo wrote:
zhiwiller wrote:
dothemontecarlo wrote:I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
There's a reason you aren't allowed to...
Please, anyone, enlighten me. Why not?
Because some stupid lawmaker thought that iras were for retirment savings not for gambling.
And because your potential for loss when shorting is theoretically unlimited. Contributions to retirement accounts on the other hand are very limited.
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Post by Xyrus »

To elaborate a little more on grumel's post, shorting usually involves borrowing (i.e, margin). This is very risky as if you lose, you could lose big and fast (margin call). That's why some were recommending using puts instead, as then the worst case scenario is that you just lose the money you had on the put. Puts are allowed in retirement accounts, margin is not and for very good reason. A couple of bad moves and you just turned you're retirement account into a debt.

Basic options trading isn't that hard to understand. Options can be anywhere from deep in-the-money to deep out-of-the-money. A deep in the money option is going to cost you. A deep out of the money will usually be very cheap.

I'm not quite sure what option chain you were looking at, but a Jan 09 option is running around $4 on $80, and the Jan 10 option is around $8. These would normally be considered expensive since they are deep OTM, but due to the volatility and length of contract it seems like pretty normal pricing.

Another option approach is to use Fixed Return Options when USO gets added to the list of approved stocks. They limit your downside as well as your upside but overall, but they are cheaper to buy (they always cost 0-$100) and easier to understand. They're still in the pilot phase so there are only a few stocks you can play with. But basically, calls and puts will always cost you somewehere between 0 and $100. The more in the money, the closer to $100 it will be. If you're in the money when it expires, you get $100 (so you're profit is $100 - cost of option). You don't get to exercise the option for stock however.

I'll slap my disclaimer on this. Shorting of any sort in a retirement account is probably not the wisest choice. I wouldn't even mess with options unless your using them long term (LEAPS) for hedging, and even then I wouldn't do it (but that's just me).

I mentioned a couple of ETFs earlier that short oil/commodities in general, though.

~X~

*NOTE: In retirement accounts you are limited to writing covered calls and covered puts (but you can buy any option you want).
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Post by dothemontecarlo »

jpsfranks wrote:
grumel wrote:
dothemontecarlo wrote:
zhiwiller wrote:
dothemontecarlo wrote:I'm looking for an instrument that does the shorting for me, b/c I would be speculating from an IRA or 401k account, where I am not allowed to short securities.
There's a reason you aren't allowed to...
Please, anyone, enlighten me. Why not?
Because some stupid lawmaker thought that iras were for retirment savings not for gambling.
And because your potential for loss when shorting is theoretically unlimited. Contributions to retirement accounts on the other hand are very limited.
So the public policy behind the restriction is purely paternalistic. Hmm. I wish I weren't so restricted, b/c I can assess the costs and benefits. But many can't, and will follow the advice of self-interested advisors, brokers, and other agents, and lose their shirts in the process. So they need protection. I guess I'm ambivalent about the policy.

The unintended consequence, however, is that the more difficult it is (whether for legal reasons or for pragmatic reasons, like high bid-ask spreads and brokers charging too high an interest rate on margin accounts) for traders to short securities, the more likely it is that bubbles will form. See WSJ article. It might be better for the economy if barriers to shorting, etc., were lowered.
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Post by Rose21 »

IMHO, you can't count on being able to cover effectively in this volatile environment. Try getting caught in a "limit up" situation. Not where I want to be.

On the issue of retirement accounts: A more cynical view is that the restrictions aid in the effort to pump the markets.
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Post by jpsfranks »

dothemontecarlo wrote:
jpsfranks wrote: And because your potential for loss when shorting is theoretically unlimited. Contributions to retirement accounts on the other hand are very limited.
So the public policy behind the restriction is purely paternalistic. Hmm. I wish I weren't so restricted, b/c I can assess the costs and benefits. But many can't, and will follow the advice of self-interested advisors, brokers, and other agents, and lose their shirts in the process. So they need protection. I guess I'm ambivalent about the policy.
My point was that margin in retirement accounts would allow for the possibility of being upside down in your account with no way to deposit more without running afoul of annual contribution limits. I had always assumed this was the reason for disallowing margin.
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Post by gassert »

You can blame it on politics, but shorting in your IRA is clearly also not allowed because you have unlimited losses. There are restrictions on contributions. You can only add $X per yr. If you borrow stock in your IRA and sell it and you realize the risk, suddenly you have to deposit more money. You can't let someone shorting contrbute more to their IRA just because they are investing differently than someone going long.
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Post by dothemontecarlo »

gassert wrote:You can blame it on politics, but shorting in your IRA is clearly also not allowed because you have unlimited losses. There are restrictions on contributions. You can only add $X per yr. If you borrow stock in your IRA and sell it and you realize the risk, suddenly you have to deposit more money. You can't let someone shorting contrbute more to their IRA just because they are investing differently than someone going long.
Well, to prevent that all that is needed a prohibition on any personal or other external guarantees or recourse on shorted securities in a retirement account. And as I understand it, the law prohibits that anyway. So your account could go to 0, but not negative. What it would mean is that your broker would have a margin requirement and charge a high enough margin interest to compensate for the risk of your account becoming insolvent -- kind of like what your broker already does for your non-retirement accounts.
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Post by Cosmo »

manatee wrote:The big oil companies such as XOM, BP, etc would be good places to start. You don't need to worry about Exxon having some windfall from a new oil field since they aren't taking on any. Therefore their price should closely correlate oil prices.
I would be very careful shorting XOM, seeing that it is the biggest component of the S&P 500. A significant decrease in oil would likely result in a major stock market rally. XOM would likely rally as well, but probably less so compared to other S&P companies.

My two bytes worth,

Cosmo
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Post by Valuethinker »

Cosmo wrote:
manatee wrote:The big oil companies such as XOM, BP, etc would be good places to start. You don't need to worry about Exxon having some windfall from a new oil field since they aren't taking on any. Therefore their price should closely correlate oil prices.
I would be very careful shorting XOM, seeing that it is the biggest component of the S&P 500. A significant decrease in oil would likely result in a major stock market rally. XOM would likely rally as well, but probably less so compared to other S&P companies.

My two bytes worth,

Cosmo
XOM is also strange in many other ways.

Consistently one of the best dividend payers in the S&P500-- going back for 50 years or so at least. As long as that dividend is held, income oriented investors will hold XOM.

Has a very high level of individual/ retail ownership. For example, grandmother of a neighbour, former secretary at National City Bank (now known as Citicorp or Citigroup), secretary to one Walter Wriston (later Chairman). She died at 94 about 10 years ago, having owned XOM since the mid 1930s. Her capital gains at death was (almost) the share price.

So betting that XOM is a play on the oil price strikes me as a fairly risky thing to do.

Schlumberger or Haliburton or the like may have a greater correlation with the oil price.

My own view is that oil was too cheap. It may now be too expensive, but, in light of where world supply and demand are, not by much.

It's difficult to make the case that oil is actually expensive at the moment, except in contrast with price history that was set when oil was a lot easier to find, and emerging economies were not growing as quickly.


As Matt Simmons says 'gasoline is still the cheapest liquid substance you can buy in your local gas station. Both bottled water and soda pop cost more per gallon'.
(I've haven't bought gas in the US recently to check).

It's also worth remembering that gasoline in London costs £1.15/ litre or about US $2.30 so $8.74/ US gal. And yet traffic is our worst problem.

If the world oil price were about $200/bl, US gasoline would be around $7/gal I believe, so still cheaper than London.
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Post by financialguy »

stratton wrote:
financialguy wrote:You could always put a little money into equities that stand to do well if oil falls -- e.g., plastics companies and airlines.
I'd assert *any* equity will do well if the price of oil falls.

Paul
Hmm... interesting point.
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