An ETF is an investment fund traded on stock exchanges that provides an easy avenue for investors to gain exposure to the markets without allocating time and effort into researching and purchasing any single company. But things can become much more complicated when the ETF owns the complex, sector-specific instruments such as futures contracts. An example of this sort of complication displayed itself in the recent blow-up of USO, the United States Oil Fund.
As the price of crude oil collapsed, many investors who are not oil experts looked to take advantage of the situation by purchasing USO, first result when searching online for the term “Oil ETF.” The fund has recently reached the limit for the number of shares it is authorized to issue. The new influx of demand, combined with the limited number of shares, actually caused the price of USO to trade higher than the net asset value of the fund.
But rather than merely gaining exposure to the spot crude oil market, these new investors unknowingly exposed themselves to the complex risks of the crude oil futures market due to USO holding such a large futures position.
USO is under tremendous strain due to a crisis regarding the physical storage of oil. The available storage space for oil is running out, and the cost of storage is rising. The difference between each month’s oil future contract highlights the cost of storage. Bad news for new eager owners of USO because USO has no intention of taking physical delivery and must pay the price to roll their position from one month to the next.
Those who have storage determine the price at which they are willing to buy as the contract nears expiration. The high cost of storage can explain why we have seen headlines reading “Oil trades at $-41 per barrel.” A few unfortunate traders were stuck still holding crude oil futures contracts the day before expiration with no place to store the oil they owned. They wanted so badly to sell the contracts before expiration that they were willing to sell them at negative prices to someone with storage space.
Even though ETFs may seem like a very low risk, inexpensive method of gaining exposure to the market, they can be quite complicated and carry risks that may not seem obvious. At Fogel Capital Management, we often take the approach of going around ETFs and directly purchasing individual securities for our clients. By doing this, our clients can avoid paying excessive fees and taking on unseen risks like in the case of USO. If you are interested in taking advantage of the opportunities the market is currently presenting to investors, we can implement our analysis of your portfolio and design an investment strategy to achieve your financial goals. Call Fogel Capital today at (772) 223-9686 for a free portfolio consultation.