I have made a few posts lately about the odd behavior in DUG. I pointed out that it wasn’t really a play on oil as a pure play as XOM and some other names play a part in the dynamic. Trader Mike did a great post on the real deal. I had a problem with the link so here is the whole enchilada.

Know What’s in Your ETF and How the ETF is Calculated

One of the Fast Money guys mentioned the UltraShort Oil & Gas ProShares ETF (DUG) on yesterday’s show. He questioned how that ETF, which is the double inverse of oil & gas could be up for the day while oil was also up. A quick look at what DUG actually is gives the answer:

UltraShort Oil & Gas ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas IndexSM

That “daily” part adds one complication to the picture. From the article ‘Understanding ProShares’ Long-Term Performance’ on ProShares’ site:

ProShares are designed to provide either 200%, -200% or -100% of index performance on a daily basis (before fees and expenses).

A common misconception is that ProShares should also provide 200%, -200% or -100% of index performance over longer periods, such as a week, month or year. However, ProShares’ returns may be greater than—or less than—what you’d expect over longer periods.

The article goes on to explain how & why this happens. But the question about how DUG could be up while the price of oil was also up is answered by looking at what comprises DUG — the Dow Jones U.S. Oil & Gas IndexSM. That index “measures the performance of the energy sector of the U.S. equity market. Component companies include oil drilling equipment and services, coal, oil companies-major, oil companies-secondary, pipelines, liquid, solid or gaseous fossil fuel producers and service companies.” Note that the actual price of oil is not mentioned. When you look at how that index is constructed you’ll see that ExxonMobil Corp. (XOM) makes up 28%, Chevron Corp. is 11% and ConocoPhillips is 7%. So at least 46% of the index is big oil companies (major integrated oil & gas). Then the question is how does the price of oil relate to movements in those oil companies? Below I’ve plotted oil vs. the index and Exxon Mobil over the last 12 months. (For ease of charting I’m going to use the United States Oil Fund ETF (USO) as a proxy for oil. USO may have its own issues but it tracks the actual price of oil close enough to make my point.)

This shows that the price of oil has seriously outperformed the index and Exxon Mobil. Here are the actual percentage changes for each:

  • USO (oil) was up 113.2%
  • the Dow Jones U.S. Oil & Gas IndexSM was up 24.5%
  • Exxon Mobil was up 9.3%
  • DUG was down 44.1%

Well at least USO and the Oil & Gas Index went in the same direction over the last 12 months. But on any given day, like today, they could trade opposite each other. And that means that DUG, on any given day, could trade with oil instead of opposite oil. I think many people would assume that if oil was down 5% DUG would be up 10%. That’s clearly not a good assumption to make I’m seeing a lot of people talking about buying DUG to profit from a drop in oil prices. Given the performance data above I think they’d be better off shorting USO. (That is, if they can find shares of it to borrow — I’ve had problems with that in the past.) Puts on USO may do the trick too.

Hopefully those who are trading DUG know that they’re not playing the price of oil directly and won’t be surprised on days like today when DUG and oil trade in the same direction. You’ve always got to know what comprises any ETF. I know that Google directs a lot of people to my list of inverse ETFs who are specifically searching for a way to short oil. Hopefully they do more research than just look at the name of the ETF and really find out what they’re getting.

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