How To Short Oil With ETFs

inverseOil production in North America is booming, and it is now beginning to have a huge impact on global hydrocarbon markets. In fact, some believe that the U.S. will eventually overtake Saudi Arabia and Russia as the world’s biggest producer of the key commodity, with some calling for the surge to happen by the end of the decade.

This push towards energy self-sufficiency is largely thanks to the combination of fracking and oil shale, as previously unobtainable supplies are now being unlocked with relative ease. The amounts are so impressive that the International Energy Agency recently declared the production surge as a ‘supply shock’ that is causing ‘ripple effects through all aspects of the oil industry’.

The Paris-based organization also stated that this positive supply shock could be as ‘transformative for the oil industry as was the rise of Chinese demand during the last 15 years’. So clearly, analysts and investors should take note of this incredible supply trend and its potentially far-reaching impact on the vital oil market.

Some have already begun to do this, as oil has had trouble breaking into triple digit territory, and it remains mired in an $80-95/bbl. range. And with the positive supply trends in the market, not to mention sluggishness in key countries around the globe, oil could have further to fall in the near term.

That is why investors may want to think about shorting oil as a way to take advantage not only of the strong dollar and broad commodity weakness, but some of the special features that are impacting the oil market in particular. While a futures or short-stock approach are possibilities, there are a host of lower risk short oil ETF options which may make more sense for many investors.

That is because these short oil ETFs prevent investors from losing more than their initial investment, while they may also be cheaper than borrowing oil stocks or utilizing futures contracts. So for investors seeking to make a short play on oil, consider any of the following ETFs as interesting choices:

-2x Short Oil ETF Choices

ProShares UltraShort DJ-UBS Crude Oil ETF (NYSEARCA:SCO)

Easily the most popular in the short oil ETF market is SCO, a product that tracks the daily performance of the Dow Jones-UBS Crude Oil Sub-index. This approach gives twice the inverse performance, on a daily basis of WTI crude oil (see More Trouble for Oil Services ETFs?).

Costs are a bit steep in this ETF, as fees run at 95 basis points a year for this specialized exposure. However, volume and assets under management are great, as about one million shares change hands on a daily basis.

PowerShares DB Crude Oil Double Short ETN (NYSEARCA:DTO)

For an ETN approach to inverse crude oil investing, consider the popular DTO for exposure. This product follows a benchmark of crude oil futures contracts with -2x exposure that rebalances on a monthly basis.

Thanks to this monthly rebalancing, the decay is likely to be less in the product, while it is also a relatively cheap choice in the space, coming in at 75 basis points a year in fees. While AUM isn’t that great for DTO– $65 million—the volume is relatively solid at about 200,000 shares a day so this product should be quite tradable.

Other (less popular) short oil ETFs:

PowerShares DB Crude Oil Short ETN (NYSEARCA:SZO)

This is arguably the least risky of the bunch, offering investors -1x short exposure to WTI crude. The ETN is rebalanced on a monthly basis though, so decay rebalancing issues are minimized, while it also adds in the yield from short-term T-bills as well (read Three ETFs for the Unconventional Oil Revolution).

The product charges investors 75 basis points a year for exposure, making it a relatively cheap choice in the inverse ETF market. SZO doesn’t have that much volume though, so bid ask spreads might be a little wide in this fund.

VelocityShares 3x Inverse Crude ETN (NYSEARCA:DWTI)

This product is one of the riskier plays in the short oil market, utilizing -3x exposure with daily rebalancing. This is accomplished by following the S&P GSCI Crude Oil Index, which offers up exposure to WTI crude oil.

This note is also a bit on the pricier side, as costs come in at 1.35% a year, putting at the high end even in the leverage market. Additionally, volume and assets are quite low, so this might not be the most tradable note out there.

Bottom Line

The outlook for oil in the near term isn’t that great. Demand from key countries is quite sluggish while a strong dollar is keeping a lid on commodities as well.

Then, when you add in the incredible production statistics that are hitting the oil market, you get a great case to be bearish in the near term. Fortunately though, there are a number of ways to play this trend with ETFs, allowing investors to profit from a bet on a supply shock and lower oil prices in the near term.

This article is brought to you courtesy of Eric Dutram From Zacks.

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