$3.6bn crude bet puts price on stupidity

[Alexpung]

This sounds like word games. I don't think most people would agree that "spot performance" includes storage costs. If this is some kind of industry standard definition, provide a citation. Regardless, the author's point about there being a drag on returns of the fund compared to a simple price-return of oil is absolutely correct.

There is no instrument that allow you to buy "spot oil" without paying storage cost one way or another, so saying "a simple price-return of oil" is just fairy dust.

If you look at returns, what's the point if you don't think of the carry cost? If you compare the return of two stock index do you just look at the index points and disregard fx and dividend?

 

[cruisecontrol]

There is no instrument that allow you to buy "spot oil" without paying storage cost one way or another, so saying "a simple price-return of oil" is just fairy dust.

If you look at returns, what's the point if you don't think of the carry cost? If you compare the return of two stock index do you just look at the index points and disregard fx and dividend?

If I said that VXX underperforms VIX, would you also tell me that was "bollocks" because "there's no instrument that allows you to buy VIX" and "you get VIX performance by buying VXX"?

 

[VolSkewTrader]

When USO fund managers sell the front month and buy the following month in WTI during a super contango like we have now, its net asset value (NAV) falls in proportion to the negative roll yield betweem the 2 months. This results in the price of USO falling or underperforming underlying CL whenever they have to roll the long futures into the following expiration every month. The shareholders of USO eat the losses (drop in NAV = drop in USO price) during rollover in a contango market.

https://seekingalpha.com/article/4338311-betting-on-higher-oil-prices-uso-is-not-right-vehicle

https://seekingalpha.com/article/4339102-uso-now-detaching-from-reality

 

[FrankInLa]

I don't think the author in your links understands backwardation and contango. He states that backwardation means that supply is lower than demand and vice versa for contango. This is nonsense. Supply and demand is completely balanced through the current price of an asset, cash product or derivative.

Contango means that the market prices in the expectation of higher future prices than current prices and vice versa for backwardation. That's all there is to this similarly than yield curves.

When USO fund managers sell the front month and buy the following month in WTI during a super contango like we have now, its net asset value (NAV) falls in proportion to the negative roll yield betweem the 2 months. This results in the price of USO falling or underperforming underlying CL whenever they have to roll the long futures into the following expiration every month. The shareholders of USO eat the losses (drop in NAV = drop in USO price) during rollover in a contango market.

https://seekingalpha.com/article/4338311-betting-on-higher-oil-prices-uso-is-not-right-vehicle

https://seekingalpha.com/article/4339102-uso-now-detaching-from-reality

 

[SunTrader]

... Regardless, the author's point about there being a drag on returns of the fund compared to a simple price-return of oil is absolutely correct.

That.

And why it is bought and sold mainly by retail crowd, as opposed to traders.

 

[SunTrader]

I don't think the author in your links understands backwardation and contango. He states that backwardation means that supply is lower than demand and vice versa for contango. This is nonsense. Supply and demand is completely balanced through the current price of an asset, cash product or derivative.

Contango means that the market prices in the expectation of higher future prices than current prices and vice versa for backwardation. That's all there is to this similarly than yield curves.

Contango in commodities such as oil that involve cost of storage, shipping and insuring. That is mainly why the higher price. Not just whether demand will be greater in the future. Do YOU understand this?

 

[Tomaz26]

We can debate this topic until the moon turns blue, but the fact is that it is hard to make money when futures are in steep contango and it helps when they are in backwardation. Sure it gives you the whole month when you roll from one futures contract at 15$ and have to buy second month for 20$. But in this case spot has to increase 30% and you still do not make any money! This is the point! And then next month the same scenario, and again, and again. After a few months you can have spot rise 100 % from 15$ to 30$ and you make exactly 0$!!! That is why when you look at spot price charts which most people do, you see people say wow, had I bought oil at 15$ and sold it at 30$ I could have make easy 100% return.. Well no.. Yes if you do it physically which no retail trader can. As soon as you introduce futures, you buy high and usually sell low. The only time you make money is when spot rises faster than was anticipated in futures pricing curve and steep contango. Currently a few months out futures trade at 30$ while spot is 15$. So you can buy december futures now and pay 30$. If spot rises 100% until december, you make exactly 0$.. So how then is steep contango not a major headwind? You cannot buy oil at 15$ now to sell it for 30$ in december. No way.. And this is where 99 % of retail goes wrong. Chasing USO. Because they know oil will not stay that cheap for long when they look at spot price. But they do not realize that further out months already price a rebound in. So the only way to make money is if you think rebound will be faster and more severe. If december oil is trading at 35$ and you buy it now for 30$, you pocket 5$ difference. If there was no steep congango you actualy could now purchase december month futures cheaper than current month, in backwardation. So with spot at 15$ you could buy december futures for 13$ and lets keep the same scenario where oil then rises 100%. You could sell your 13$ futures contract for 130% gain while in first scenario oil increased the same 100% and you made 0$.. So again how is steep contango not huge pain in the ass?

 

[FrankInLa]

Incorrect. Many times in history has oil traded in backwardation. As recently as 1 year ago. All that while also costs of storage, shipping, and insurance was involved. Those impact pricing of futures but don't determine whether a commodity trades in contango or backwardation.

Contango in commodities such as oil that involve cost of storage, shipping and insuring. That is mainly why the higher price. Not just whether demand will be greater in the future. Do YOU understand this?

 

[Tomaz26]

Exactly! Oil actually traded in backwardation at least 50% of the time or so.. So storage costs are usually not a big factor regarding pricing, supply and demand is..

 

[FrankInLa]

You can't make money by shorting a futures contract? And you still don't understand that pnl is NOT calculated across different contracts. You enter one contract month and exit the same contract month. Then you enter into the next contract month. That is how traders roll a futures position. Via manual roll or trading the spread.

Here is a simple example (I just work with direct futures prices, not notional for clarity sake)

May contract:
price when entering : 20
Price when exiting : 15

June contract:
Price when entering : 18
Price when exiting : 25

You paid 20 dollars to enter a long in May contract. Then close to expiration you flatten the position and receive 15 dollars. A loss of 5 dollars. Then you open a June contract at 18 dollars on the same day you sold the May contract. At close to expiration of the June contract you receive 25 dollars. A gain of 7 dollars and an overall profit of 2 dollars.

Same example with a calendar spread:

Buy at 20, roll by paying 3, at end receive 25. Net pnl is 2 dollars.

Nowhere does the spread between May and June contracts enter into pnl.

Why can people still not understand basic futures 101 accounting? Contango at no point entered into pnl. You could as well have shorted the future with different pnl implications and still neither the spread nor contango factored into pnl whatsoever. Nothing dictates that a futures price must decrease over a certain holding period when the curve is in contango.

I hope this example clarified once and for all this misunderstanding.

We can debate this topic until the moon turns blue, but the fact is that it is hard to make money when futures are in steep contango and it helps when they are in backwardation. Sure it gives you the whole month when you roll from one futures contract at 15$ and have to buy second month for 20$. But in this case spot has to increase 30% and you still do not make any money! This is the point! And then next month the same scenario, and again, and again. After a few months you can have spot rise 100 % from 15$ to 30$ and you make exactly 0$!!! That is why when you look at spot price charts which most people do, you see people say wow, had I bought oil at 15$ and sold it at 30$ I could have make easy 100% return.. Well no.. Yes if you do it physically which no retail trader can. As soon as you introduce futures, you buy high and usually sell low. The only time you make money is when spot rises faster than was anticipated in futures pricing curve and steep contango. Currently a few months out futures trade at 30$ while spot is 15$. So you can buy december futures now and pay 30$. If spot rises 100% until december, you make exactly 0$.. So how then is steep contango not a major headwind? You cannot buy oil at 15$ now to sell it for 30$ in december. No way.. And this is where 99 % of retail goes wrong. Chasing USO. Because they know oil will not stay that cheap for long when they look at spot price. But they do not realize that further out months already price a rebound in. So the only way to make money is if you think rebound will be faster and more severe. If december oil is trading at 35$ and you buy it now for 30$, you pocket 5$ difference. If there was no steep congango you actualy could now purchase december month futures cheaper than current month, in backwardation. So with spot at 15$ you could buy december futures for 13$ and lets keep the same scenario where oil then rises 100%. You could sell your 13$ futures contract for 130% gain while in first scenario oil increased the same 100% and you made 0$.. So again how is steep contango not huge pain in the ass?